Overview
The theory of consumer choice is interested in the manner through which make decisions on the amount of money that they can commit on their preferences considering their budget constraints (Levin & Milgrom, 2004). All consumers have a budget past which they cannot spend. This budget is influenced by the wealth and income of the individual consumers. The budgets erect constraints on the ability of consumers to acquire their preferences. The consumer choice theory informs the choices a consumer will make considering the price of a certain good or service and his income.
The exploration of the consumer choice theory helps one understand how incomes and the preferences of the consumers affect the demand curve (Levin & Milgrom, 2004). In addition to the demand curves, the paper will also explore how the consumer choice theory affects higher wages and higher interest rates. The paper will also explore the role that asymmetric information plays in economic transactions, the Condorcet Paradox and the Arrow’s Impossibility, and the irrationality of people in behavior economics.
Impact of Consumer Choice Theory on Demand Curves
The demand curve of the consumer is a combination of the decisions that the consumer makes under the influence of the indifference curves and the budget constraints. The consumption decisions are reflected on the demand curve. The demand curve for the inferior goods will shift outwards when the effect of the income is dominant over the substitution effect.
Impact of Consumer Choice Theory on Higher Wages
The consumption decision of a consumer might change drastically when the wages increase. Higher wages means that the consumer has a higher income compared to previously. This means that the budget constraint is eased on the consumer. More precisely, the budget constraint is shifted outwards when the income of the consumer increases. This means that a new optimum that is influenced by the new budget constraints influences the decisions of the consumer on the goods and services to buy. More normal goods as opposed to inferior goods are purchased in this instance compared to the previous income or the situation as it would be if the income was lower.
Impact of Consumer Choice Theory on Higher Interest Rates
High interest rates have an effect on various aspects of the product. One of the key aspects, and one that is relevant to the consume choice theory is the price of the products. Considering a scenario where the income of the consumer remains constant event tough the prices increase, the budget constraint of the consumer shifts inwards. This means a new optimum that is lower that the initial optimum is created. The consumption choices are made on the new optimum. In this scenario, more of the inferior goods are consumed compared to the normal goods. This is because more money is required to acquire the normal goods and the income of the consumer has remained unchanged.
The Role of Asymmetric Information in Economic Transactions
Asymmetric information can occurred when one of the parties taking part in a transaction possess more of information of superior quality when compared to the other party. Most commonly, the seller in the transaction possess more information about the product compared to the buyer; although the opposite is also possible. The asymmetric information results an imbalance of power between the two parties taking part in the transaction. This means that the party with more information can easily exploit the other party in the transaction (Christopher, Core, Taylor & Verrecchia, 2011).
On a larger scale, asymmetric information can result in market failure. This is because of two problems in the transactions that occur as a result of the asymmetric information. One of the problems is adverse selection (Christopher et al., 2011). This problem occurs when one of the parties involved in the transaction exploits the imbalance in information prior to the transaction. For instance, more people who have impaired health might buy life insurance policies compared to people who are healthy.
The other problem that results from asymmetric information is the moral hazard (Christopher et al., 2011). This occurs when the party exploits the imbalance in information after the economic transaction is complete. For instance, a person who has purchased fire insurance on his house might burn down the house in order to receive the compensation from the insurance company.
The Condorcet Paradox and the Arrow’s Impossibility in the Political Economy
The voting paradox is characterized by the cyclic nature of collective preferences even when the individual voters in the scenario have transitive as opposed to cyclic preferences (Kalai, 2002). The paradox is brought about by the fact that there might arise conflicts in the wishes of the majority voters even when they voted for one candidate (Kalai, 2002). This phenomenon is significant in a political economy, especially in the agenda setting forums such Congress where the agenda setters can manipulate situation to achieve preferred outcomes.
The Arrow’s Impossibility theorem holds that rank-order voting systems cannot be designed to guarantee that if all the voters in a group prefer a certain candidate over another, then the entire group prefers that candidate; that if the preferences of individual voters between two candidates remain constant, then the preferences of the group between the candidates will also remain constant; and that a single voter does not wield the power sufficient enough to determine the preference of the group (Kalai, 2002).
Rational and Irrational Behavior
Rational behavior explains a situation where the decision-making process is influenced by choices that lead to the highest benefit. The benefit does not have to be material as some people might pursue emotional gain. When this concept is applied in economics, it explores the behavior of the people in a given market. It explains a decision-making process in the market where a logical sense is applied in making the choices and there is a limited influence of emotions. However, the behavior of people in the market place is not always rational.
For instance, an investor will commit his money into a company into which financial models advise against on the account of positive feelings. Such a decision does not show evidence of a logical sense. From a logical perspective, a stock that has showed signs of sustained decline in the stock market should be disposed of to avoid further losses. An investor might make an irrational decision to hold on to the stock citing a gut feeling. While some irrational behavior is based on asymmetric information, the most behavior is based on an emotional element.
References
Christopher, A., Core, J., Taylor, D., Verrecchia, R. (2011). When Does Information Asymmetry Affect the Cost of Capital? Journal of Accounting Research, 49: 1-40.
Kalai, G. (2002). A Fourier-theoretic perspective on the Condorcet paradox and Arrow's theorem. Advances in Applied Mathematics, 29(3): 412-426.
Levin, J. and Milgrom, P. (2004). Consumer theory. Retrieved from https://web.stanford.edu/~jdlevin/Econ%20202/Consumer%20Theory.pdf
