The Theory Of Consumer Behavior Assumes That Consumers Attempt To Maximize: Free Essay Example

Consumer behavior is the way that consumers choose to spend their incomes. The orthodox theory of consumer behavior assumes that consumers choose their expenditures to maximize their utility subject to constraints imposed by their preferences and budget. Under this theory, consumption behavior is independent of the consumption of others, consumer’s tastes are fully known, and information available to the consumer is free, complete, and reliable.

Orthodox economics assume that consumers are rational and sovereign whilst making their decisions. The failure of the orthodox theory of consumer behavior to evaluate the impact of advertising, network externalities, social restrictions imposed by the environment of the consumer, and the limitations of human cognitive capacity that causes individuals to consume in an irrational manner are the main criticisms of that microeconomic model.

The orthodox theory assumes that people’s demands for a good are independent of one another and that the consumption behavior of any individual is independent of the consumption of others.1 When the theory of individual behavior is applied to the behavior of many individuals in the market, however, it is important to assess the extent that an individual’s demand may be affected by what other people are consuming.

2 This assumption distinguishes functional demand as the demand for a commodity due to the qualities inherent in the commodity itself and nonfunctional demand as demand for a good that is due to the factors that are not inherent in the commodity itself.

The effect of non-functional demand is also known as network externality.4 Inherent in the desire to be a part of a group, stylish, and fashionable, Bandwagon goods are those whose demand is increased due to the fact that others are also consuming the same commodity.

5 In this case when the network externality will have a positive effect on the consumer demand, an individual will demand more/less of the commodity at a given price because some or all other individuals in the market demand more/less of the commodity.6 Bandwagon effect is common in children’s toys (i.e. Barbie dolls, Nintendo games, Harry Potter books) or fashionable clothing.

If the Bandwagon effect is predominant for a given commodity, then the demand curve is more elastic than it normally would be.7 (See Figure 1.1) An increase in demand has an opposite effect for Snob goods. Snob goods represent the desire to be exclusive, different, or to disassociate oneself from the “common herd”.8 Common examples would be collector’s pieces or valuable artwork. In this case, both the value and the demand for a good are decreased due to the fact that others are also consuming or increasing their consumption of the same commodity.

Individual consumer is thus negatively correlated with the total market demand and the demand curve for snob goods is thus less elastic than the demand curve where there is no snob effect.10 (See Figure 1.2) As can be seen from their respective graphs, Bandwagon and Snob effects have inverse behavior, but since they are not influenced by utility inherent in the goods but rather by the behavior of other consumers, they violate the orthodox theory of consumer behavior.

The quantity of the good demanded grows in response to the growth of purchases by individuals. The demand for a good shifts to the right from Da to Dd due to the Bandwagon effect as the price of the product falls from $Yn to $Yo. The quantity of a good that an individual demands falls in response to the growth of purchases by other individuals. The demand for the good shifts to the left from Da to Dd as the price falls from from $Yn to $Yo and more people by the good.

Although the orthodox theory of consumer behavior assumes that prices and income only constrain what the consumer can afford, prices also affect preferences. A high price may lead a consumer to believe that few others will buy a product, a reaction that may be accounted for by the Snob effect.13 The utility of goods that are affected by the Veblen effect, or the theory of conspicuous consumption, depends not only on the inherent qualities of the unit, but also on the price paid for it.

The real price of the commodity is the price the consumer paid for the commodity in terms of money and the conspicuous price if the price other people think the consumer paid for the commodity and which determines conspicuous consumption utility.15 The demand curve for a Veblen good is less elastic than without the Veblen effect.16 Consumer preferences that are influenced by price thus also violate the assumptions of the orthodox theory.

Although standard neoclassical economists would argue that advertising just additionally informs consumers about products and improves efficiency of markets by ensuring that markets operate on full information, opposition to the theory of consumer behavior would claim that advertising has a dominant influence on consumer choice by changing consumer preferences rather than providing objective facts.17 The theory of consumer behavior would argue that an extra pound spent in one direction provides the same amount of satisfaction spent in any other way on the utility curve.18 The more sensitive the consumer is to price change (i.e. the greater the elasticity of the demand curve), the smaller the margin of cost for the firm hoping to maximize profits.

Thus, a firms’ desire to raise the price of its product will be offset by its recognition that it will lose substantial sales if it does so.20 Firms are, however, able to effectively reduce the price elasticity of demand for their products by creating psychological dependence through advertisement. Achieved through the Bandwagon effect or by increasing market power by offering competitive services and reducing competition as a result of consumer loyalty in the long run, advertising influences purchases by reducing the set of goods consumers regard. Purchases are thus determined by the role of advertisement rather than consumers maximizing a fixed utility function subject to known constraints.

In its assumptions, the orthodox theory of consumer behavior assumes that individuals optimize their choices, have the necessary information to make a decision of what to consume based on preferences, and that nothing else limits their actions other than their budget constraint. “Man, however, is a developing, learning, and social animal and it would be absurd to assume that the preferences of a consumer are fully known and that they remain unaffected by time and the environment.”21 Critics of the orthodox theory, however, point out that the set of available goods and services is continually changing, that knowledge is partial, expensive, and unreliable and that consumers’ own tastes evolve as their age or marital status changes.

A large proportion of consumers are members of multi-person households who are limited in their decisions by the attempt to satisfy more than one person in their spending.23 Optimization in the sense that all possible alternatives are considered and the best possible is chosen to maximize utility.24 In the words of Nobel laureate Herbert Simon, however, consumers are “satisfiers not maximizers.

This would imply that consumers work partly on the basis of “satisficing” or repeating satisfactory purchases until something goes wrong or on the basis of trial and error by exploring their reactions to products they have not previously tried.26 This commonplace and frequent everyday behavior of a shopper goes against the underlying principles of the orthodox theory of consumer theory and is thus legitimate grounds for its criticism.

Consumer behavior is also known as the standard rational choice model. As its name implies, this model assumes that individuals behave in a rational manner evaluating events in terms of their overall effect on total wealth and maximum utility.27 Numerous examples of human behavior, however, contradict the predictions of the standard rational choice model because as many psychologists would argue, that behavior is the result of limitations in human cognitive capacity.28 These behaviors are also known as the rational (Orthodox theory) model and behavioral (how people actually think) models.

People often use mental accounting systems that reduce the complexity of their decisions at the expense of consistency with the axioms of rational choice.29 Unlike the orthodox model, people tend to give losses much heavier decision weight than gains.30 Decisions under uncertainty also often violate the prescriptions of the expected utility model.31 People tend to be risk averse in the domain of gains but risk seeking in the domain of losses.32 In addition, the orthodox theory fails to account for purchases that are neither planned nor calculated but are due to sudden urges and serve no rational purpose.33 Due to unpredictable human behavior and peoples’ “incapability to act like rational human beings”34, the orthodox theory again fails to account for all behaviors of consumer traits.

The orthodox theory of consumer behavior is a microeconomic model that represents a simplified description of the reality in order to concentrate on the underlying principles of an individual’s utility, budget constraint, and consumer demand. Although the theory fails to account for network externalities, role of advertising, and irrational human behavior, it is successful in providing a general picture of how individuals consume. It would probably be beneficial if the orthodox theory attempted to incorporate some aspect of impact of network externalities and role of advertising into its assumptions, but due to the many variations of these influences, it would probably be extremely difficult to establish a generalization for the impacts since they would vary depending on the type of goods and time.

Due to varying individual circumstances and irrational behavior of each consumer, it would be even harder to establish a common basis to include in the theory because it would vary with time, environment, and goods. Behavioral models of choice may be more successful in predicting actual decisions compared to the rational choice model, but have no normative significance. The rational choice model that dictates how a consumer should behave, however, at least implies what would be beneficial to the individual, even though the latter would not be able to react accordingly as a result of limited cognitive capacity and social circumstances.

Due to complex social behavior and varying time, environment and social structure, a changed orthodox theory would again remain inexact and thus again criticized. As a result, it would probably prove best if the theory was not modified but remained continually criticized since it is from these criticisms that an economist discovers how consumer behavior truly functions.