Household Behavior And Consumer Choices

Household Behavior and Consumer Choices

Introduction:

Issues of household behavior and consumer choices, lie in the field of microeconomics. Microeconomics, sometimes called the price theory is a branch of economics that concerns itself with the study of how households, individuals, and firms make their own private decisions on how to allocate scarce resources. In this research paper, I will seek to apply economic theories and mostly the consumer theory to analyze these decisions and their effects on consumption, interests and wages.

ANALYSIS:

DEFINITIONS:

HOUSEHOLD BEHAVIOR:

Household behavior is principally viewed and analyzed as the theory of consumer demand of various commodities or generally household consumption. In addition to this household behavior also concerns itself with production of commodities or services and the supply of labor by households.

Consumer demand on the other hand concerns itself with how demand functions for various commodities are derived. This derivation is done considering the rational choice model based on utility maximization. In this analysis, economic constraints like budgets, income and commodity prices are considered for specific households.

Household Behavior and Consumer Choices

The consumer theory studies the issue of household likes and preferences applying indifference curves as well as budget constraints and relates these preferences to consumes demand curves. There are many economic variables that are used in the analysis of these preferences. Among the major variables, include the price per unit of a certain good and the money incomes of the specific consumers.

A change in the price of a good usually has two major effects. Firstly, there is the substitution effect and secondly there is the income effect. The substitution effect usually arises from the relative change in prices of consumer goods. On the other hand, the income effect arises from changes in the purchasing power of the available money wage or income.

The diagram below depicts the relationship between consumer demand and prices through indifference curves given budget constraints.

The price effect:

When the price of good Y increases, the budget line will shift from BC2 to BC1. This is because when the price of good y increases households will buy less of the good but they will still buy the same quantity of good X as long as they wish. In order to maximize his or her utility the consumer will have to move from indifference curve I2 to I1. By doing this the consumer will be able to enjoy his/her preferences as normal.

Incase the price of commodity Y decreases the budget line or the budget constraint will move from BC1 to BC2. This is because the consumer will now be able to purchase more of commodity y while at the same time enjoying the same amount of good X. in the same case, the consumer in order to maximize his/her utility will move from indifference curve I1 to I2. The

Household Behavior and Consumer Choices

same scenario will be applicable for price changes of good X.

The income effect:

The income effect is depicted in the diagram below.

An increase or decrease of the consumer’s disposable income will cause a parallel shift of the consumer’s budget constraint. An increase in the disposable income will cause the budget constraint to shift to the right while a decrease in the income will cause the budget constraint to shift to the left. This applies for normal goods since the indifference curves will react differently for inferior goods and Giffen goods (goods with a snob appeal).

For inferior goods as the income increases, less of the commodity will be consumed. This is because the increased income will cause the consumers to seek higher or better goods. For Giffen goods as the income, increases the amount of goods purchased may either increase or remain the same.

Generally, the effects can be summed up to the substitution effect and the income effect. The substitution effect usually is a price change that affects the slope of the budget line (constraint), but leaves the consumer on the same equilibrium indifference curve. In cases where the good in question is a normal good then the price effect will outweigh the substitution effect, but in cases where the good is an inferior good then the substitution effect will outweigh the price effect.

Leisure-labor tradeoff:

Household Behavior and Consumer Choices

The time that any consumer has to allocate for different purposes is called time endowment. The price of leisure is analyzed using the consumer theory, with some slight adjustments. In this case, leisure is assumed to be a good and consumption is considered to be another good. Since consumers have scarce and finite time then they will have to choose between leisure, which earns no money, and consumption of labor that earns an income.

Regardless of this trade off the change in the unit price of leisure will have a huge effect on the working time since a reduction or an increase in the price of labor will lead to less work and more work respectively.

Wage and interest rates:

Wages can be analyzed both as a cause and as effect of consumer behavior. They are a cause in the sense that as wages increase so does the consumption of households increase. On the other hand, wages can be viewed as an effect of consumption behavior since they are indirectly determined by the consumer price index.

Both real and nominal interest rates are affected by consumer behaviors. Depending on the liquidity within the economy, the consumption behavior of households can cause an increase or decrease in the level of interest rates.

Conclusion:

Many variables that are dealt with in microeconomics usually have an indirect effect in the field of macroeconomics. The determination of the national income do consider the value that households contribute either in the form of consumption or services that they render.

Household Behavior and Consumer Choices

In addition to this, the level of inflation is also slightly affected by the consumption and expenditure behaviors of the households. Consumer theory plays a very important role in explaining household behaviors. However, the field of macroeconomics also needs to be keenly looked at since it deals with economic aggregates.

References:

Mankiw, N. G. (2004), Principles of economics (3rd Ed.), Chicago, ILLIOIS: Thomson South-Western

McWilliams Gary. Analyzing Customers…the wall street journal,Monday, November 8, 2004. Available at: http://online.wsj.com/article/SB109986994931767086.html

Philip Hardwick (1982), an Introduction to Modern Economics, Longman, U.K