CHAPTER 8 : THEORY OF THE CONSUMER

8.1 Nature of the Consumer

(A) Meaning of Microeconomics: The term micro suggests an infinitesimally minute quantity. Microeconomics deals with the smallest economic units. It is concerned with the behavior of an individual consumer or an individual household or an individual business firm. There are other interesting features of the micro branch of economics. It attempts to analyze the behavior of consumers and producers as they tend to optimize on their transactions. Optimization means simultaneous maximization and minimization. As a consumer one attempts to maximize utility or satisfaction and minimize expenditure. As a producer one attempts to maximize profits and minimize cost of production.

Microeconomics is a static approach in the sense it concentrates on individual behavior in a very short period of time. It analyzes instant changes in behavior. It avoids taking account of long term and external effects on such behavior. Since economic life is highly complex and interdependent, such a simple approach requires the help of strong assumptions. These assumptions are together stated in the form of the ceteris paribus clause. It implies that the analysis operates under the condition "other things are equal or constant or remain unchanged" when individual behavior alters. Other things include income of the individual, number of members of a family, price of substitutes, taste of a consumer, technical conditions of production, supply of labor, land, capital and other resources, fiscal and monetary policies of the government, etc.

Microeconomics makes use of marginal methods for analyzing economic problems. Marginal changes arise out of small adjustments in economic activities. The concept of margin is equivalent to the first derivative method of mathematics. Finally, microeconomics is essentially a price level analysis. It attempts to study the effect of small variations in prices on individual behavior. It avoids the problem of long-term shifts in the total economic conditions, such as in the levels of real national income. Microeconomics makes assumptions about the constancy of the size of national income and employment. As a result of this, microeconomics becomes a partial equilibrium analysis.

Microeconomics is also alternatively known as neoclassical economic analysis. It has been developed since 1870 onwards by Jevons, Walras, Menger, Marshall, Pareto, Hicks, Samuelson and others. Though microeconomics is highly restrictive because of its assumptions, it is a simple yet important part of economic theory.

In the present chapter the behavior of a consumer will be our main concern. A similar analysis of the behavior of a firm will follow in the next chapter.

(B) Utility and Preferences: We continuously experience a large variety of wants. The wants are unlimited and recurring. Though wants are numerous no individual can ever satisfy all of his wants since the satisfaction of wants needs some resources or means to be spent.

Resources may be in the form of money, time, intelligence, physical strength, goodwill etc. Such resources are always limited or scarce. Therefore every individual has to spend his resources carefully and wisely. Such behavior is called rational or economic behavior.

When one behaves economically he has to make a choice and decide his preference while spending his limited resources.

The satisfaction of wants is an objective of economic activity. A person with a limited income of $10 may have multiple wants. He may want to spend on food, garments, entertainment, cosmetics etc. But his limited income does not allow him to acquire all these. Therefore he has to make a choice about one or more of his needs which can be satisfied immediately. The decision is rationally based on the urgency and importance of a particular want or end. Once the choice is made the necessary goods are bought and consumed. The act of consumption brings satisfaction or utility to a consumer. Some goods like fruit or snacks can be consumed only once but durable goods can be used repeatedly. A wristwatch, garments, furniture etc. are durable goods. When in use they are considered to be consumed. This is because of the fact that consumption of a good leads to reduction or destruction of its utility. What can be consumed is the utility of a good.

(C) Relative and subjective nature of utility: Wants are satisfied with the help of various goods. The want satisfying quality of goods is called their utility. The quality of food to satisfy hunger and that of water to satisfy thirst are therefore their respective utilities. But utility is not an absolute or objective quality of any good. This is because wants are satiable. Therefore utility of a good is relative and subjective. Utility is relative to a person and his wants. Cigarettes have utility for a smoker or medicines are useful for someone ill. This means that for a non-smoker or a healthy person these goods can bring no utility. Again for the same individual a cup of tea is highly refreshing in the morning, less refreshing in the evening and totally useless late at night. Therefore utility is subjective and depends upon person to person as well as the state of mind of a person at different times.