INTERMEDIATE MICROECONOMICS

2. Consumer Theory

2.1 Who are Consumers?

Who is the consumer?  There are in fact two types of consumers.  First, there are individuals and their households.  Goods and services intended for these types of consumers are known as 'final' or 'consumer' goods and services.  Goods and services intended for business as an input to the production function are known as 'intermediate' or 'producers' goods.  The final consumer is the focus of  microeconomic theory. 

And what do consumer's get from consuming goods & services?   They get 'utility'.  In common language, this seems to suggests 'usefulness'.  However, in economics 'utility' has a much deeper and in some ways darker meaning within the 'felicitous calculus' of Jeremy Bentham (1748-1832).  In simple terms, Bentham believed that all of human existence could be explained by the search for pleasure and the avoidance of pain.  Thus 'pleasure and pain are the sovereign rulers of the State'.   He believed that pleasure and pain could be reduced to what would eventually prove to be physically measurable units called 'utiles', hence 'utilitarianism'.  Thus utilitarianism is radically materialistic at root. 

Another name for utilitarianism, as defined by Bentham, is 'ethical hedonism'. The search for pleasure was inhibited in Bentham's scheme by the assumption that human beings carried a God-given ethic of right and wrong - essentially the  Protestant work ethic.   Once that ethic faded, however, we were left with only 'Me-ism': only my pleasure counts, and anything I do to increase it, no matter the pain and suffering to others, does not matter!  It is ironic that what Plato feared most about Art was realized by economics:

We must remain firm in our conviction that hymns to the gods and praise of famous men are the only poetry which ought to be admitted into our State.  For if you go beyond this and allow honeyed muse to enter, either in epic or lyric verse, not law and the reason of mankind, which by common consent have been ever deemed best, but pleasure and pain will be the rulers in our State.  Book X of The Republic

Joseph Schumpeter in his classic the History of Economic Analysis described utilitarianism as "the shallowest of all conceivable philosophies of life that stands indeed in a position irreconcilable antagonism to the rest of them" (Schumpeter 1949: 133).

Subsequent economists have struggled to escape the grasping hand of Bentham.  Thus of consumer goods and services, Alfred Lord Marshall noted:

Increasingly wealth is enabling people to buy things of all kinds to suit the fancy, with but a secondary regard to their powers of wearing; so that in all kinds of clothing and furniture it is every day more true that it is the pattern which sells the things (Marshall 1920; 177-8).

The consumer goods market, as we know it today, began to emerged in the 18th century with the arrival of a mass 'middle class' or bourgeoisie.  Before that time the lower classes, in the main, produced their own consumer goods at home while the upper classes either directly employed craftspersons and artisans in their 'great houses' or estates or contracted 'freemen' to produce the quality goods required by 'nobles'. 

Grant McCraken, in his book Culture and Consumption: New Approaches to the Symbolic Character of Consumer Goods and Activities (Indiana University Press 1988), outlines the origin of this modern consumption pattern.  I quote from my book review:

McCraken begins by describing a consumer boom in 16th century England in which, he argues, it was the court of Elizabeth I, not Louis XIV a century later, that revolutionized the nature of consumption. To keep Catholic and other nobles loyal in troubled times, she exploited the "hegemonic power of things to communicate the legitimacy of Her Rule". Before Her Time, the family was the traditional unit of consumption. One bought for future generations. One bought that which would last because it took five generations of patina to move one's family into the "gentle" class. She, however, forced those aspiring to rise above their station to spend now, for themselves -- to be the prettiest peacock at court, the most generous. Like the potlach (praised as the quintessential example of "caring" capitalism by George Gilder in his influential 1981 paean to the Reagan Revolution entitled Wealth and Poverty) members of the court were compelled to consume their way to honour, power and gentility. This shift from long-term to short-term consumption had a dramatic impact on the evolution of Western culture contributing to the breakdown of feudal society. At the same time, however, in England and other European countries, punitive feudal 'sumptuary' legislation remained in place to be used by the State to restrict "status fraud", i.e. persons of the lower classes dressing or otherwise pretending to a higher station in society.

McCraken goes on to explore the consumer revolution of the 18th century with particular emphasis on the role of Josiah Wedgewood in shifting the source of fashion from the nobility to the bourgeois marketeer, or what McCraken calls "market ethnographers" who watched for patterns and regularlities and adjusted products and marketing strategies to take advantage of emerging opportunities. By the 19th century such observers of society attained unprecedented social mobility. Thus McCraken notes: "In the person of Beau Brummel we see nothing less than the abrogation of powers of influence that had previously been possessed only by the monarch".

Continuing his journey towards the present, McCraken highlights the emergence and impact of the department store, mail order catalogue and advertising. In fact, McCraken manages to shift the entire focus of the Industrial Revolution from the production-side, which is the principle object of economic analysis, towards the consumption-side. He also demonstrates that older patterns of consumption, e.g. patina, remain vestigal part of contemporary consumption.

The last third of the book is focused on more theoretical issues but still spiced with real world observations. McCraken considers issues like: clothing as language (which he effectively discounts); "meaning" manufacture by advertisers who place a product within a positive, socially acceptable context and try to transfer the acceptability of the context to the product; rehabilitation of the "trickle-down' theory; the evocative power of things; and Diderot Unities and Effects, i.e. forces that compel the individual to maintain cultural consistency in consumption as well as forces which encourage the individual to change lifestyle.

While McCraken's work can be seen in the context of the emerging field of consumer hedonics -- consumers buy fulfillment of fantasies, not solutions to problems -- an approach pioneered by Hirschman and Holbrook, the fact remains that McCraken roots this new concept of consumer behaviour in the history of Western civilization. For those concerned with the economic implications of the arts, McCraken provides a foundation upon which much fruitful research and study can be conducted and from which a greater appreciation of the North American "yuppie" trade deficit will surely emerge.

Book Review, H.H. Chartrand, Journal of Arts Management & Law, Volume 19, No. 4, Winter 1990

Second, there are firms that purchase goods and services as 'inputs' to the production process of final goods and services.  Goods and services purchased by firms are known as 'intermediate' or 'producer' goods and services.  Taste and style play a significantly less important role.  Rather it is price and technical quality that dominate the producers' goods or the 'input' or 'factor of production' marketplace.  Firms as consumers are the subject of a separate part of microeconomic analysis known as 'factor market' analysis.

In what follows only consumer or final goods and services are considered.  As an introduction to a more detailed analysis of consumer behaviour consider these words by Tibor Scitovsky:

The most important price taker in our society is the consumer who faces set offers in practically all his market transactions. He has an income which he can spend on different goods and services in a variety of ways; and the alternative patterns of expenditure open to him are determined by the variety of offers and the structure of prices facing him. Of the alternatives made available to him by his income and his market opportunities, he will choose the one that best conforms to his preferences. The way in which he actually spends his income therefore depends on his personal preferences, on the size of his income, and on his market opportunities. In the following, we shall discuss, first, the way in which the market's offers and the consumer's income determine the latter's market behavior and, second, how changes in income and market offers affect his behavior. The consumer's preferences, however, we shall regard as fixed. The economist's task is to analyze how and to what extent economic activity conforms to consumers' preferences; but these he cannot question and must accept as given. ¹

How can we find out what the consumer's preferences are? We can hardly question him on the subject and so establish his scale of preferences. This would be a lengthy and clumsy process even if applied to only one person and is obviously impossible to apply to all members of the community. We can, however, infer the consumer's preferences from his market behavior, on the assumption that this is governed by rational choice and is not merely a matter of habit or accident.  When the consumer spends his income in a certain way, we assume that he finds this the best way of spending his income at the existing structure of market prices, because it it were not, he would surely spend his income differently.  The theory of consumer's behavior, therefore, is purely descriptive and describes the behavior of the rational consumer.  We can neither prescribe how the consumer should behave nor judge his behavior by comparison to an ideal behavior pattern, because we have no such ideal pattern.  To establish an ideal behavior pattern would require independent information of the consumer's tastes and preferences; whereas we know these only as they are reflected in his market behavior.   This means conformity of the consumer's market behavior to his preferences is the assumption we start out with and not something that can be proved or disproved by our analysis. 

1. Producers, however, do not always accept consumers' preferences as given but often try to influence them through advertising and other means. This raises the problem as to whether consumers' preferences, dependent as they are on advertising, should really be regarded as the ultimate standard.

Tibor Scitovsky, Welfare and Competition,

Irwin, Homewood, Illinois, 1971, pp. 27-28.