Microeconomic and Consumer Theories - Essay Example

? Microeconomic Theory Consumer theory is an economic theory explaining the relationship between consumers’ purchasing choices and income and it involves preferences, indifference curves, and budget constraints (Levin & Milgrom 2004, pp. 5-15). Consumer theory is based on an idea that consumers always tend to consume products that can give them maximum satisfaction for money they are willing and able to spend. Being that customers are always restrained by budget, they normally purchase cheaper products if prices hike but products that are more expensive when prices decrease (Dean 2009, p. 1-12). On the other hand, consumers will purchase expensive products whenever their income goes up and less expensive products when the income reduces. It is apparent that consumers normally make various choices with an aim of maximizing benefits they receive in return for the money they spend and the theory posits that consumers spend only the money they have without accounting for saved money as this writing explains. Dean (2009, p. 25-42) explains that the level of satisfaction that a consumer obtains from purchasing various products is based on utility function whose arguments affect consumer’s overall satisfaction level. There are trade-offs faced by the consumers while making consumption decisions and these can be explained with utility function. Diminishing marginal utility describes consumer’s preferences in a very significant way making some economic analysis to take it as a basic starting point. According to Levin & Milgrom (2004, pp. 5-15), consumer theory illustrates that a consumer prefers a group of products packaged together called bundle and that a consumer would prefer a bundle and disregard the brand. The theory explains that consumers would rather base their purchase decision on the number of products in the bundle or the size of the bundle but not the product’s brand. Sassatelli (2007, pp. 57-60) explains that indifference curves are the contours of a utility function and each shows all combinations of goods between which a consumer is indifferent. Looking at the marginal rate of substitution, the indifference curve has a negative slope throughout thus showing that beginning from any consumption bundle, if consumers decide to give up on one good, they would add more of another substitute as a way of maintaining their level of utility (Sassatelli 2007, pp. 57-60). Consumers normally substitute products for others even if the two goods are not the same and this describes most people’s preferences. Slope of an indifference curve shows the maximum number of units of a particular good a consumer is willing to substitute to acquire one unit of the other thus providing an economic way of understanding what the indifference curve really show. It is also worth noting that the slope of an indifference curve depends on the consumption bundle considered. The slope of an indifference curve represents the marginal rate of substitution between two products (Sirgy 1982, pp. 287-300). Summary of Simon Herbert Article Simon attempts to explain the link between psychology and economics by resting on a notion of economics as a science and a discipline (Simon 1959, pp. 253-260). He explains that economics as a science can be used in describing and predicting the behavior of various kinds of consumers and entrepreneurs. His research endeavor intended to understand the processes that participate in human decision making although despite his effort to investigate the issue he did not have a huge impact in the decision making (Zalega 2012, pp. 77-99). He rejected the assumption of perfect rationality made in the mainstream economics and he further emphasized the limitations of the cognitive processes. Simon (1959, pp. 255-265) points out that economics is widely preoccupied by normative economics while descriptive macroeconomics offers the scientific base for policy prescription. He explains how the theory of consumer demand was derived from indifference curve and considering of utility as an ordinal measure. He further explains empirical studies that show that it is possible to determine empirically whether consumers experience utility functions of an appropriate kind. Simon points out that there are difficulties experienced while trying to measure utilities making most experiments to be limited to confronting the subject. He concludes that the utility theory may imply that consumers are interested in maximizing their utility or the real world is so complicated that the theory has little relevance to real choices of a consumer (Simon 1959, pp. 257-265). However, normative economics has led to new utility theory with formal framework that provides the basis for most of the normative models of management as well as applications that can be used in decision-making. He has introduced the binary choice experiment that is used by both economists and physiologists in testing the most diverse kinds of hypotheses. Simon (1959, pp. 255-264) disputes that this method may not be effective in handling utility maximizing subject for the classical theory of utility in its simplest form since few subjects behave in as per the experiment requirement. Simon also writes about probabilistic preferences, which he asserts that is empirically testable in principle because it provides reasonable interpretation about the idea of “indifference” than the classical theory (Zalega 2012, pp. 77-99). While tackling areas in which economics share common interest with other behavioral sciences it has been clear that economist’s operational goal has been the assumption of maximization which has deterred economists to understand an economic man. Simon attempts to explain the manner in which an economic man is related to his environment and the various mechanisms and processes he is involved in while achieving his goals. He posits that understanding and assessment of static equilibrium as approximations play integral role in determining the link between economics and psychology (Sirgy 1982, pp. 287-300). In most cases, the demand for an economic man has always been derived from the economy as a profession but currently there have been emergence of new areas and theories that have subjected the economic environment into complexity and change. According to Simon, the revived interest in utility theory as well as its application to consumer’s choice under uncertainty, consumer saving and spending have largely changed the relationship between economics and psychology (Simon 1959, pp. 268-279). Moreover, the requirements of normative macroeconomics and management science for a fuller theory of the firm have resulted into numerous endeavors to understand the real processes involved in making business decisions. In addition, Simon explains that the idea of adaptive and satisfying behavior that has been hugely derived from psychology have critically challenged the classical picture of the maximizing entrepreneur. Simon (1959, pp. 265-275) has further tackled the area of imperfect competition and oligopoly which he describes as active despite the fact that it has caused more problems than the once it has solved. He says that the activity has exposed a community of interest amongst many social scientists who consider bargaining as part of political and economic process. Simon indicates that decision making processes is always associated with future prediction and that both psychologists and economists normally use several approaches, empirically and theoretically in studying the formation of expectation. Simon explains that whatever has made theory of decision making significant have also made its development difficult and that various approaches have been fragmented. He asserts that attention on choice, conflict of interest, and creation of expectations (Simon 1959, pp. 275-282). Simon’s censure of conventional economic models of perfect rationality initiated several research programs in psychology and behavioral economics but these programs developed independently with very little communication between them. Tversky and Kahneman’s approach however dominated the decision-making program psychology and empirically tests Simon’s suggestions and proved that they were right. It is apparent that scholars studying expert decision-making but did not follow Simon’s approach ended in a worse conclusion and they are always irrational in their domains of expertise (Thaler 1980, pp. 3960). Neoclassical consumer theory initiates its analysis by considering individuals as consumers yet they may also act as producers in the market yet this function is ignored in consumer theory. The neoclassical theory assumes that the consumer is faced with a choice from amongst consumption bundles i.e. they choose between two bundles. It is apparent that the assumption refers to the consumer’s psychological beliefs or feelings that determine his choice behavior and while the consumer bases his actions on his preferences, the two exist independent of one another. According to Mcdonald & Wearing (2013, 69-75), preferences need to be regarded, as facts of action and indifference can never be the basis for action and such kind of concept do not have a place in economics. Consumers may indeed have preferences, as defined but neoclassical consumer theory does not exclude certain individuals from its analysis though no individual are being excluded outright. According to Hansen & Christensen (2007, pp. 100-109), MRS derives solely from the underlying preference relation although it appears to exist in our minds. MRS does not seem real although it is used as abridging tool that lets economists avoid sophistications of discrete analysis as it produces more or less similar results. A notion that consumers take prices as exogenous may not be right since prices are determined by both supply and demand. Arguing the consumer’s decisions assume the very prices their decisions affect is to argue in a circle and this is due to misunderstanding recalling how the mainstream conceives of preferences and consumer choice (Mcdonald & Wearing 2013, 21-30). The most significant thing may be to explain the implications of consumer’s behavior but not explaining why consumers behave the way they do. People criticizing an indifference curve analysis of comparing amount of utils different bundles provide the consumer are groundless since the utility function is not the right focus because the indifference set has nothing to do with it (Lancaster, Kelvin, J 1966, 135-141). Modern economists’ work differs from basic consumer theory making it hard to understand it although the most complicated research is based on the fundamentals of consumer theory. Elementary consumer theory based on indifference curve and utility function analysis have improved thus clarifying some common misconceptions and enhanced numerous critiques against its claims (Hansen & Christensen 2007, pp. 100-109). Deluge of statistical analysis and mathematical modeling in the modern economics hides the real nature of its claims particularly the concept of indifference that most economists rely on yet they do very little about (Mcdonald & Wearing 2013, 69-75). Indifference means a consumer is not able to make a choice between two bundles because they come indifferent to the point of inaction. This is untrue because in the real world, there are choices to be made and consumers commit to specific courses of action since an individual can never lack a choice. It is therefore apparent that indifference is a speculative counter factual claim that cannot be empirically verified yet modern economists rely on indifference. Bibliographies Dean, M 2009, Consumer Theory, Lecture Notes for Fall 2009 Introductory Microeconomics - Brown University, 1-61, retrieved 27 December, 2013, . Hansen, F., & Christensen, S 2007, Emotions, Advertising and Consumer Choice, [Denmark], Copenhagen Business School Press. Lancaster, Kelvin, J 1966, a New Approach To Consumer Theory, Journal of Political Economy Vol. 74, No. 2, Pp. 132-157, retrieved 27 December, 2013, . Levin, Janathan & Milgrom, P 2004, Introduction to Choice Theory, 1-25, retrieved 27 December, 2013, . Mcdonald, M., & Wearing, S 2013, Social Psychology and Theories of Consumer Culture a Political Economy Perspective, Hoboken, Taylor and Francis. Sassatelli, R 2007, Consumer Culture History, Theory and Politics, London, Sage Publications. Simon, H., A 1959, “Theories of Decision-Making in Economics and Behavioral Science,” American Economic Review, Vol. 49, Pp. 253-83.  Sirgy, J 1982, Self-Concept in Consumer Behavior: A Critical Review, Journal of Consumer Research Vol. 9, No. 3, Pp. 287-300, 27 December, 2013, . Thaler, R 1980, Toward a Positive Theory of Consumer Choice, Journal of Economic Behavior and Organization L (1980) 3960, retrieved, 27 December, 2013, . Zalega, T. 2012, "Rationality and Methods of Research into Consumer Market Behaviour,” Equilibrium, Vol. 7, No. 4, Pp. 77-99. Read More