- The theory of consumer choice, chapter 21 “The Theory of Consumer Choice”, looks at how consumers make choices when faced with trade-offs and how they react to environmental changes. Consumer choice theory explains how people come to their decisions. It can be used to answer various queries, as we’ve shown. It can clarify how a person makes decisions regarding work and play, consumption and saving, and other choices.
- Given the consumer’s money and the pricing of the commodities, a consumer’s budget restriction reveals the conceivable combinations of various goods she can purchase. The commodities’ relative cost equals the slope of the budget restriction.
- The indifference curves of the consumer show the consumer’s preferences. The numerous packages of items that make the consumer equally satisfied are depicted on an indifference curve. Higher indifference curve points are chosen above lower indifference curve points. The slope of an indifference curve, or the rate at which a customer is prepared to exchange one commodity for another, is determined at every given location.
- The consumer chooses the point on their budget limit that is located on the highest indifference curve to maximize their savings. The slope of the budget constraint (measured by the relative price of the goods) equals the slope of the indifference curve (measured by the marginal rate of substitution between the goods), and the consumer’s valuation of the two goods (determined by the marginal rate of substitution) equals the market valuation at this point (measured by the relative price).
- An income effect and a substitution effect are the two ways that a product’s price change affects the consumer’s decision-making. The change in consumption that results from a decreased price making the consumer wealthier is known as the income effect. A price shift that encourages increased consumption of the good that has become less expensive is known as the substitution effect. While the substitution impact is expressed by a movement along an indifference curve to a point with a different slope, the income effect is reflected by a movement from a lower to a higher indifference curve.
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