Consumer choice

The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption (as measured by their preferences subject to limitations on their expenditures), by maximizing utility subject to a consumer budget constraint. Factors influencing consumers' evaluation of the utility of goods include: income level, cultural factors, product information and physio-psychological factors. Consumption is separated from production, logically, because two different economic agents are involved. In the first case, consumption is determined by the individual. Their specific tastes or preferences determine the amount of utility they derive from goods and services they consume. In the second case, a producer has different motives to the consumer in that they are focussed on the profit they make. This is explained further by producer theory. The models that make up consumer theory are used to represent prospectively observable demand patterns for an individual buyer on the hypothesis of constrained optimization. Prominent variables used to explain the rate at which the good is purchased (demanded) are the price per unit of that good, prices of related goods, and wealth of the consumer. The law of demand states that the rate of consumption falls as the price of the good rises, even when the consumer is monetarily compensated for the effect of the higher price; this is called the substitution effect. As the price of a good rises, consumers will substitute away from that good, choosing more of other alternatives. If no compensation for the price rise occurs, as is usual, then the decline in overall purchasing power due to the price rise leads, for most goods, to a further decline in the quantity demanded; this is called the income effect. As the wealth of the individual rises, demand for most products increases, shifting the demand curve higher at all possible prices.