Consumption, income and decision making

Main idea: Each of us is a consumer because we all purchase goods and services to satisfy our needs and wants. There are certain factors that influence consumers’ decisions to buy  and their ability to make a rational choice.

Disposable and Discretionary Income You and everyone around you are consumers and, as such, play an important role in the economic system. A consumeris any person or group that buys or uses goods and services to satisfy personal needs and wants. Consumers spend on a wide variety of things—food, clothing, housing, automobiles, and movie tickets, for example.

A person’s role as a consumer depends on his or her ability to consume. This ability to consume, in turn, depends on available income and how much of it a person chooses to spend now or save.

Income can be both disposable and discretionary. Disposable incomeis the money income a person has left after all taxes have been paid. People spend their disposable income on many kinds of goods and services. First, they buy the necessities: food, clothing, and housing. Any leftover income, which can be saved or spent on extras such as luxury items or entertainment, is called discretionary income.

Education, occupation, experience, and health can all make differences in a person’s earning power and thus in his or her ability to consume. Where a person lives can also influence how much he or she earns—wages in some regions of the country are higher than in other regions. Inheriting money or property also affects earning power.

      Decision Making as a Consumer Spending choices involve several decisions. The initial decision a consumer must make is whether to buy an item in the first place. This may sound so basic as to be unnecessary to mention, but how many times do you actually think about the reasons for the purchase you are about to make? When deciding how to spend your money, do you concentrate on items you need first, and then consider items you want? Do you consider the trade-offs involved? As we will see, consumer decisions involve three main considerations.

Scarce Resources After you have decided to make a purchase, at least two  scarce resources are involved—income and time. Before you spend your money, you need to invest time in obtaining information about the product you wish to buy. Suppose, for example, that you wish to buy a mountain bike. How can you obtain information about the characteristics of the numerous brands and models and the prices of each? You should first visit retail stores and do some research on the Internet to compare prices. The time spent researching online or visiting stores to check models and prices is a cost to you. This time, and the money you  eventually spend on the mountain bike, cannot be used for anything else.   

Opportunity Cost Almost all of the steps in consumer decision making  involve an opportunity cost. As you know, opportunity cost is the value of the highest alternative choice that you did not make. When considering this cost, you should think not only about whether you should buy an item in the first place, but also about the quality of the item if you do choose to buy it.

In general, a high-quality product costs more than a medium- or low-quality product. Suppose that you want to buy new cross-training shoes and are trying to decide between two different pairs. One model has a pump system that allows you to get a closer fit on your ankle, and the other does not. The pump system model costs $80 more than the other model. If you choose the higher-priced shoe, you will sacrifice $80. The opportunity cost of the pump model over the lesser-quality model shoe is whatever else you would have chosen to buy with that $80.

When considering opportunity costs, you should think carefully about whether the features of the higher-quality product are important to you, or whether you would rather spend the extra money elsewhere. In our training shoes example, for

instance, think about whether a pump system is really something you need or want in a shoe. Is this feature really important to you? Or would you rather spend the $80 on something else?

Rational Choice When you make consumer decisions based on opportunity cost, you are engaging in rational choice. Economists define rational choice as the alternative that has the greatest perceivedvalue.

Rational choice involves choosing the best-quality item that is the least expensive from among comparable quality products. As a consumer, you will make rational choices when you purchase the goods and services you believe can best satisfy your wants.

Do not get the impression that wise consumers will all make the same choices. Remember the definition: A rational choice is one that generates the greatest perceived value for any given expenditure. Each person’s value system for his or

her expenditures is different. Rational choices that are based on careful consumer decision making will still lead to billions of different consumer choices yearly.

Unit 5