Topic 2 consumer and business

\Topic 2 – Consumers & business

1. Role of consumers
‘Consumer sovereignty’ refers to the pattern of consumer spending in an economy will determine patterns of production and resource allocation.

Since firms are rational profit maximising entities, they will produce what the consumers want to buy and how much they buy.

Consumer sovereignty is not only important for maximising profits, it will also act to ensure that firms maximise their efficiency.

If by producing at technical efficiency (lowest cost)
Producing what consumers want (allocated efficiency)
Responding to changes in consumer preferences (dynamic efficiency)

However, in todays society, consumer sovereignty is not absolute, firms spend a lot of money on marketing campaigns that are designed to manipulate consumer-spending behaviour. E.g. advertising campaigns.

Firms often undertake misleading or deceptive advertising – designed to distort purchasing decisions.

Planned obsolescence – sometimes technology exists that would result in future purchases of products, e.g. light bulbs, that don’t burn out, pantihose that don’t run. However it is not in the interest of the business to sell these products.

Anti-competitive behaviour
Sometimes there are very limited competitors for consumers to choose from – again diminishing consumer sovereignty.

Patterns of spending
1. Y=C+S
Consumption it part of income that’s not saved
Savings is income not spent
Consumption is consumer spending on goods and services for satisfaction of immediate wants – durable or non-durable.

For any given level of income (Y)
If there is an increase in consumption, there will be a fall in savings
If increase in savings, fall in consumption

The proportion of any extra income that is earned by a person that is spent by them on consumption is called the marginal propensity to consume (MPC).

So MPC = change in consumption Change in income

Y=C+S APC+APS= 1 MPC+MPS = 1
Y
C
S
APC
APS
MPC
MPS
100
80
20
0.8
0.20
-
-