What is consumer theory?
Consumer theory is a theory in economics that attempts to explain the relationship between a consumer's purchase choices and income. The idea behind consumer theory is that consumers will try to buy the products that will bring them the highest levels of benefit or pleasure for the amount of money they can afford. On a limited budget, they will buy cheaper products if prices go up and more expensive products if prices go down. They will also buy more expensive products if their income increases and less expensive products if their income decreases. Consumers make these decisions in an effort to maximize the benefit they receive for the money they spend.
The theory assumes that consumers will only spend the money they actually have and does not explain the money savings. This is called a budget constraint. According to consumer theory, the budget constraint will affect consumer spending decisions, limiting their choices. If a consumer can only spend the money they have, any option that costs more should be eliminated. For example, when buying an economy refrigerator for $800 dollars (USD), the consumer will choose the best model for that amount or less, but not a model that costs $900.
Then consumer theory discusses preferences. In general, the theory assumes that the consumer prefers a group of packaged products, commonly called packaging. A consumer generally prefers a package, regardless of brand, but bases their purchase decision on something like the number of products in the package or the size of the package. For example, a consumer may prefer a package with extra-large bottles of brand A shampoo and conditioner rather than a package of smaller bottles of brand B shampoo and conditioner. However, if the bottles are the same size, the consumer may not having a preference for any brand, which is called indifference.
Consumer theory also looks at a factor called the substitution effect. This factor states that if the price of a product rises, the consumer will have to choose to buy less or substitute a cheaper product to buy the desired quantity. In most cases, the consumer will substitute the cheapest product when faced with this option. For example, if the consumer usually buys a certain brand of coffee and the price goes up, he will probably switch to a cheaper brand of coffee. Alternatively, if prices drop, the consumer may choose to buy more of the cheaper brand, but will usually switch to the more expensive, preferred brand.
The income effect is another factor in consumer theory. The income effect states that if a consumer's income increases, he will be able to buy more than one desired product. The consumer can also choose to substitute a different product that was previously too expensive for their budget.
An example of the income effect would be if a woman usually buys a certain brand of bag because the brand is within her budget, but she really wants a more expensive brand of bag. If your income increases, you will usually switch brands and buy the more expensive brand you want. On the other hand, if a consumer's income goes down, they will usually switch to a cheaper brand.