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Consumer Theories in Economics: Decision Making, Incentives & Preferences

Consumer Theories in Economics: Decision Making, Incentives & Preferences
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  • 0:02 Importance of Utility
  • 1:12 Optimization
  • 3:31 Preferences
  • 4:24 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Really, what do we know about consumers? Considering that there are billions around the world, our knowledge is far from perfect. However, economists have a number of ideas and assumptions about consumers that help inform their theories.

Importance of Utility

Let's say for a moment that you are the epitome of the typical consumer in a given economy. What are some of the assumptions we can make about you? Well, go on. Think about it for a second. This is harder than it sounds, isn't it? However, making assumptions about consumers is an integral part of economics; economists have to understand what causes consumers to act certain ways. Just as important, and perhaps much more practical, producers have to understand what motivates consumers, or soon there's no economy for the economists to study!

Okay, relax. Economists can make some very general assumptions about the typical consumer. By far the most important of these, and one that everything else hinges off of, is the importance of utility to the consumer. Remember that utility is the usefulness of something to an individual. Economists always assume that consumers, and producers for that matter, will work to maximize their efficiency. To put this more bluntly, economists assume that people know that you only live once and you'd better make the most of it.

Optimization

Not surprisingly, economists don't have a clever hash tag like #YOLO to emphasize this belief that people work to maximize their utility. Instead, they have the term 'optimization', which means that people are not always trying to maximize their utility, but they are always interested in new ways of doing so. Now, in a really simple economy with only a handful of goods, this would not be a very difficult thing to do. Simply make sure everyone has the goods they need and you're fine. However, we live in an economy that's anything but very simple. Literally, millions of goods and services are available in our economy, offered by equal millions of producers.

This issue of choice could be a major cause for stumbling in making assumptions about consumers, but economists just apply their base assumption that people act rationally in regards to their utility. Note that this does not mean their choices make sense in the long term. Yes, some people are going to find more utility in partying than in studying, or in going on vacation rather than paying their rent. However, in the moment, those options had the greatest utility to the individual. Thus, regardless of long-term benefits, economists assume that individuals will face choices and act to maximize their utility.

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