Consumption theory: concept, types and basic principles

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:41

Consumption theory is a fundamental concept in the field of microeconomics. Its purpose is to study various economic solutions. The priority area of research is the process of consumption by private economic agents.

Components

It is necessary to start characterizing the theory of consumption from the basics. The basic assumption in the concept under consideration is the principle of satisfying needs. It consists in the fact that the agent, that is, the subject of the consumption procedure, seeks to satisfy his own needs of a material and non-material nature. In fact, the very process of obtaining the desired benefits is the main meaning of economic activity. The better the subject does this, the greater the benefit. In turn, the very concept of benefit (utility) plays a special role in the economy. This is a necessary condition for an object to acquire an exchange value, that is, a value. The more valuable the product, the more needs of a particular person will be satisfied.

The second fundamental element in the theory of consumption is preference. The subjects of the sphere of consumption have personal preferences and desires,appropriate to their character and personality traits. All of them are different from each other. The preferences themselves are included in a special hierarchy. This suggests that economic agents put some goods above others, that is, they give them increased or decreased utility. The same scheme works with combinations of goods, that is, groups of preferences.

Utility function and rational behavior

One of the foundations of the theory of consumption is the utility function. This is the ratio between the number of goods used and the resulting utility. If we are talking about combinations of material or non-material goods, coupled with utility, then their image will be executed in the form of indifference curves. An alternative to finding consumer choice is the found preference approach. These are certain desires of people, information about which can be obtained by observing the behavior and characteristics of the life of an economic agent.

Rational behavior completes the structure of the theory of consumption. Everything is quite simple here: the subject of the sphere of consumption is trying, within the boundaries of the available budget, to achieve the maximum in satisfying his own needs. He does this solely for his own benefit, achieved through the use of goods. All possible consumption processes available to the subject are located below the budget curve. This is the name given to the combination of two goods that the consumer is able to buy if his finances have a fixed amount. This implies the assumption that the subject acts in a rational way. Additionally, it is stated that the proposal andpersonal demand has no effect on market prices. Agents themselves are only able to change the number of consumed goods.

Decisions of subjects

Decisions of private agents are almost the main value in the theory of consumption. Consumer choice is divided into two types: demand decision and supply decision. Let's start with the characteristics of the first element.

Based on the budget available to the agent, demand is formed in the markets for the provision of various benefits. Their requested number depends solely on what particular combination of benefits can bring the highest benefit to the subject. The choice is made on the basis of market prices for the goods themselves. Demand decision analysis makes it possible to designate personal demand functions. They, in turn, point to the relationship between prices and demand. This is where the concept of price elasticity of demand comes from. It also explains the relationship between income and demand. This is the income elasticity of demand.

The second type of decision in consumption theory is related to supply. Each subject of the sphere of consumption is able to offer capital or work. He does this in the factor markets. The agent thus makes two important decisions. The first decision has to do with how much capital he wants to offer in the factor markets. Such a decision includes dividing the budget into spending, that is, consumption, and saving, that is, saving. In fact, these factors are the problem of maximizing utility within the boundariescertain time. After all, the agent makes a choice between the present and potential, that is, subsequent consumption. Such an analysis, by the way, explains why the securities market exists and how it can increase profit.

The second type of supply decision is related to the amount of work and the desire to offer something in the factor markets. In this case, we are talking about the division of one's own time into free and labor. This kind of analysis provides personal job offer features.

The proposed and asked numbers of subjective goods in the theory of consumption are considered to be interconnected. The fact is that both of these groups have an impact on the budget available to the private agent.

Features of the theory

Having de alt with the basics of the concept under consideration, you should begin to study its basic features. As you know, a person acquires services and goods in the process of almost his entire life. This process has only two goals: it is the satisfaction of basic needs and the enjoyment. The choice that the consumer makes plays a big role here.

In economics, it has long been proven that the selection procedure is influenced by several factors. Their first group is called personal. This includes concepts such as age, life stage, earnings, amount of existing or potential budget, earning capacity, and so on. In fact, it is a group of personal factors that has the greatest influence on a person's choice.

The group is in second placepsychological factors. This includes the ability to selectively memorize, the skill of analysis, the ability to soberly assess the situation, and much more. Some experts point out that personal, that is, psychological characteristics, to a greater extent influence the choice in the field of obtaining pleasure.

The last two groups are called cultural and social. Everything is simple here. A person is strongly influenced by the external environment, and in particular by society. Based on the features of the surrounding world, a person makes one or another choice.

All the above issues are resolved in the economy within the framework of the theory of consumption. This theory studies the principles and main features of the rational behavior of people in the provision of services and goods. It also explains how a person is able to make a choice of market goods.

Many economists have contributed to the study of consumer consumption theory. These are researchers of the institutional sociological trend, representatives of "development economics", some historians and even Marxists. The latter, by the way, formed their own theory, where they identified welfare problems in a special way. One way or another, in the theory itself there are many unresolved and simply controversial issues. The traditional study of the concept under consideration involves the study of consumption as a natural process for the utilization of goods, with its own structure and special principles of movement.

Principles of Consumer Consumption Theory: Freedomchoice and rational behavior

The current concept is based on a number of important methodological principles. Each of them should be analyzed in detail and described further.

The first principle is consumer sovereignty and freedom of choice. One might think that the main actors in the consumption system are producers. In fact, they determine the structure and volume of production, and also have the ability to influence the price level for services and goods. The result of their effective activity is the possibility of acquiring profits.

Under such conditions, it is allowed to produce only those goods that can be sold on the market at a cost that exceeds production costs. At this point, in the economic theory of consumption, the emphasis shifts from the field of production to the consumer environment. Suppose a buyer pays a certain amount of money for a product. It exceeds the costs incurred during production. This means that the manufacturer can continue to operate. In a different situation, he is not able to sell his own goods and suffers losses. As a result, he is completely ruined. All this indicates that consumer sovereignty operates in this area. The consumer influences the production structure and volume. To do this, they form the demand for specific services and goods.

An important aspect of consumer sovereignty is the freedom of consumer choice. Here, of course, there are a number ofrestrictions. These are emergencies - like war or famine, as well as the desire to protect the population from harmful goods (like drugs, cigarettes or alcohol). The restrictions also include the desire to provide citizens with some kind of equality in consumption. Such a goal is motivated by the social policy pursued by most developed countries.

The second principle is called rational human behavior in the economic sphere. Rationality lies in the desire of the consumer to correlate his income with such a set of goods that would satisfy all the necessary needs as much as possible. On the basis of the principle of rationality, the theory of the consumption function was formulated, already discussed above.

Rarity, utility and Gossen's laws

The principle of rarity is the third fundamental element in the concept under consideration. It indicates that the production of any product is limited. The principle of utility states that any acquired good in one way or another satisfies the needs of a person. The principle of accounting for consumer income indicates the possibility of transforming needs into demand if they are given a monetary form.

The last principle is dressed in a series of laws that were formulated by the Prussian economist Hermann Gossen. All major theories of consumption are based on the axioms formulated by the scientist. The first law states that it is necessary to distinguish between the total utility of a good and its marginal utility. Decreasing marginal positive qualities are at the heart of the consumer reaching a state of equilibrium. This is the state atwhere the maximum utility is extracted from the available resources.

The content of the second law states that obtaining the maximum utility from the consumption of certain goods over a certain period of time should be based on the rational consumption of these goods. That is, one should consume in such quantities that the marginal utility of the goods consumed is equal to the same values.

Gossen says that a person who has freedom of choice, but does not have enough time, is able to achieve the maximum of his pleasure by partially using all the goods before directly consuming the greatest of the goods.

Keynes' consumption theory

Studying the concept under consideration, it is impossible not to mention the theory of John Keynes. In his view, consumption is a set of goods and services that are purchased by buyers. The amount of finance spent by the population for these purposes is in the form of consumer spending. However, part of household income is not used, but acts as savings. The farm itself is accounted for without government intervention and is denoted by the sign Yd. Consumer spending is C. Saving is S. So S=Yd - C. Consumption is closely related to the level of national income.

The consumer function looks like this:

C=Ca + MPCY.

CA here is the value of autonomous consumption, which does not depend ondisposable income. MPC - marginal propensity to realize consumption. By itself, SA characterizes the minimum degree of C. It is necessary for people and does not depend on current disposable income. In the absence of the latter, people will take on debt or cut back on savings. The horizontal axis will be disposable income, and the vertical axis will be people's spending on needs.

Thus, the main provisions of the Keynesian theory of consumption are as follows:

• Marginal propensity to consume is a result greater than zero. However, it is less than unity. As profits increase, his share, which is aimed at consumption, decreases. This is because rich people are more likely to save more than poor people.
• There are a number of factors that influence savings and consumption. These are taxes, deductions, social insurance and so on. All this has an impact on the growth of taxes, and also reduces the amount of income. The level of savings and consumption is decreasing.
• The greater the accumulated we alth, the weaker the incentive to save. This principle is the basis of a separate theory of consumption and savings.
• Changes in the price level affect the value of financial assets.

Here, a number of psychological factors such as greed, pleasure, generosity and others should be taken into account. Structural elements also play a significant role: the size of the family, the age of its members, location, budget and much more.

Theory of Relative Income

Keynes's theory of consumption was developed in the middle of the 19th century. About a centuryit was considered the only true one in economics. But in the post-war period, several alternative concepts appeared, each of which should be analyzed in detail in our material.

The doctrine of relative income is considered quite common. This concept is firmly entrenched in the group of theories of consumption and production theories. It was developed thanks to the American economist James Duesenberry. In 1949, the scientist suggested that the message about determining consumer spending by disposable income cannot be called fully reliable. Duesenberry argues that consumer decisions are prioritized by third-party acquisitions. By them, the economist meant nearest neighbors.

The essence of the concept of relative income is quite simple: a person's consumption is directly related to his current income. Moreover, the profit of the individual is compared with two factors:

• own profit received in the past;
• neighbours' income.

The generally accepted concept of consumer demand indicated that consumer satisfaction with a purchase is not related to the acquisition of other buyers. Duesenberry also tried to show that most of the buyers, as it were, "compete" with each other. The increased level of comfort that has developed in the period after the war causes a desire to be better, that is, to surpass the closest neighbors in some way. A similar demonstration effect can be traced today. People apply for loans and buyrather expensive things that, it would seem, do not correlate with their income. The desire to be a little better than it really is is still a priority. A person sacrifices his own comfort and does not act in the most rational way, just to take his rightful place among the rest.

It turns out that the concept of relative income even contradicts the basic theories of society and consumption. One of the main ideas of the sphere under consideration, namely the principle of rationality, is violated. Whether it is worth accepting such a theory as fundamental is a moot point. However, there are certainly reasonable connections and strong evidence here.

Life cycle theory

The following concept was developed by American economist Franco Modigliani in 1954. It is based on the assumption that actual consumption is not a function of current income, but of total consumer we alth. All buyers, in one way or another, constantly strive to distribute the acquired goods in such a way that the level of expenditure remains constant, and we alth is lost entirely at the end of life. It turns out that for the whole life cycle, the average propensity to consume is equal to one.

The essence of the concept is based on the hypothesis that the behavior of buyers during their entire working life should be arranged in such a way that a part of the funds for the material support of the elderly can be saved from the generated income. In youth, people have too high consumption. Often they even live in debt. At the same time, they hope to return the amount taken to mature years. And by old age, both the pension and the savings of adult children are spent on purchases.

Modigliani's alternative theory of behavior and consumption has been refuted by modern empirical research. For example, let's take the theses of American economist Jeffrey Sachs.

First of all, do not forget about the existence of precautionary savings. No one prevents a person from forming such a reserve at a young age. Modigliani's statement that purchasers who have not reached a mature age, all as one spend finances and get into debt, can be called extremely subjective and not confirmed by anything. Moreover, no basic theory of society and consumption points to this.

Secondly, the assumption is rarely laid in the mind of a person that he will live longer than he planned. People are not used to looking into the future, much less investing in it. Almost every individual lives in the present time, and therefore lays a little more for the future than he should. However, this point can be called controversial.

The third thesis is related to the possibility of diseases. People remember about possible ailments, and therefore try to take care of their he alth. In conditions of paid treatment, this can lead to additional, often quite large, costs. However, life insurance is spreading in modern society, and therefore the criticism of this thesis can be partly removed.

The fourth point is related to the desire of older people to leave an inheritance. Reasonablea person wants to leave some part of material we alth to his children, relatives, and sometimes even to charitable organizations. There is considerable empirical evidence that the savings activity of the elderly in some countries is slightly lower than that of young workers. In addition, it should be remembered that the accumulated we alth is incomparably more than all the elderly living on earth can spend.

This leads to a simple conclusion. The theory of consumer consumption, called the life cycle model, presented by Modigliani, does not fully explain consumer behavior. Obviously, the desire to secure a life in retirement is considered an important factor in savings.

Permanent Income Theory

The next modern consumption theory was developed by American economist Milton Friedman. Its essence lies in the fact that there is simply no direct connection between family income and her current needs. The consumption of various households is proportional to the degree of not actual, but permanent income. Fluctuations in real profits are not reflected in the prevailing standard of consumption.

This theory is considered quite useful in the modern scientific world. It essentially explains the response of households to temporary changes in income. Let's take a simple situation as an example. One of the family members became seriously ill. The disease itself will last at least a year. According to Keynes's concept, the consumption of such a family will decrease in proportion to the reduction in the actual income received.arrived. Meanwhile, the doctrine of permanent income directly indicates that the reduction in consumption will be manifested to a lesser extent than the decrease in income. At the same time, it will be more likely to expect the sale of assets or obtaining a loan from a bank in order to maintain the achieved standard of living. Simply put, the family will not "tighten their belts", but will try with all their might to maintain the previously existing financial situation. The same principle is used in many other theories of consumption and theories of production.

In conclusion, we should give the last alternative concept, which is nevertheless very close to the classical one. It is called the ordinalist theory of consumption. According to it, the consumer is not able to numerically measure the amount of utility received from various kinds of goods. However, he is able to compare and rank sets of goods in terms of their preference. This concept is based on such postulates as unsaturation, as well as transitivity and comparability of preferences.