by Marc Davis
Supply and Demand
Although economists all agree that the price of a product or service is a major factor in the consumer decision-making process, it's not the only factor, and it may not always be the deciding factor. But a principle of microeconomics assumes that, if all other factors are equal, as the price of a product or service goes up, demand for that product or service declines. Conversely, if the price declines, demand goes up. (For more on this read, Economics Basics: Demand And Supply.)
Based on pricing, therefore, microeconomics can forecast with reasonable accuracy what a consumer may buy, and how much of that product or service will be bought. Consumer demand - what a consumer wants and in what quantity - is called a demand curve and may be graphically plotted in a chart, like the one below.
|Figure 1: Demand Curve|
Another way to represent the demand curve is in a table like the example below. The table simply shows that demand for a product, in this case an apple pie, declines as the price for it goes up.
|A Demand Curve|
|Price of an
|Number of Apple Pies
People Want to Buy
The demand curve for apple pies may change if a factor in the decision-making process changes. Let's say a competing bakery offers cherry pies that are bigger and cheaper than the apple pies. The demand curve for apple pies may then change, with demand falling off as demand for the cherry pies goes up.
Consumer demand for both apple pies and cherry pies will depend on this price and size relationship - cherry pies are bigger and cheaper than apple pies. If the apple pie baker makes a new batch of apple pies as big as his competitor's cherry pies and offers to sell them at the same price or lower than the cherry pies, then demand for apple pies should go up.
Opportunity Cost and Elasticity
Another price or cost to the consumer which must be calculated as part of consumer buying patterns is what microeconomics calls the opportunity cost.
This "expense" or cost represents what consumers must give up in order to buy something - in other words, the tradeoff factor. If a consumer has a dollar to spend and buys a cup of coffee for a buck, then there's no money left for a donut. Conversely, if the consumer buys the donut, he or she has nothing to dunk it in. What the consumer gives up, or trades off, to buy one thing and not another is the opportunity cost.
Prices changes in a product or service, either up or down, will influence the opportunity cost to consumers. A steep increase in the price of coffee for a confirmed coffee drinker may not prevent that consumer from buying the same amount of coffee. But for the random drinker of coffee who does not need a cup or two to start the day, the price increase may cut that consumer's coffee buying.
The change in the quantity of coffee bought by the consumer as the price changes is called demand elasticity. Demand may expand like a stretched rubber band - reflecting its elasticity - if the price of coffee goes down. Or demand may contract, or become inelastic, if the price goes up. (To learn more, read Economics Basics: Elasticity.)
Microeconomics measures the demand elasticity for a product or service as its price changes using this formula:
|Elasticity = % Change in Quantity Demanded
% Change in Price
These microeconomic formulae and theories illustrate the core influences that account for consumer decision-making: price, utility and opportunity costs.
Other economic factors, of course, may also influence consumer buying choices. These may include the spending patterns of wealthy consumers for whom price considerations may not be as important as they are for the average consumer. Or a consumer with an average income may be predisposed to spend more money on a product or service because of a preference for quality over price.
Beyond the factors discussed above, several other elements also enter into the decision-making equations; these are less quantifiable. (To learn how economic factors are used in currency trading, read Forex Walkthrough: Economics.)
Extraneous Factors and Marketing
Consumer buying choices are also driven by psychological, cultural and social factors, all of which play a role in influencing preferences. The convenience factor is also a major influence on consumer buying. Some consumers patronize certain stores and retail outlets because they're in the neighborhood. Some ethnic consumers may prefer to buy from retailers that speak their language. Other consumers may buy from stores that provide easy credit. In some instances, these factors may be more important than considerations of price.
What marketing executives refer to as brand loyalty and brand recognition are also important elements that propel consumer choices. A consumer who has had a beneficial experience with a specific brand of product or service will most likely continue to purchase it, despite increases in its price - up to a point. (For more on the impact of marketing and advertising see, Advertising, Crocodiles And Moats.)
So every significant development in the study of consumer decision-making, and every aspect of the process are of great interest to the businesses community. The data and insights provided by this microeconomic research are studied by marketers and frequently employed in a firm's pricing, marketing strategies, advertising, packaging, product research and development, quality and quantity considerations, and in other factors designed to stimulate sales.
Accurate data on some aspects of consumer buying patterns and preferences can be found in print sources and on government and trade association websites. Some of this data is also available from various business associations and individual firms who conduct their own surveys and research programs to develop consumer data unique to their own businesses.
With such a large variety of elements at work in a consumer's decision-making processes - some measurable to a certain degree, some not - forecasting their behavior is, at best, an inexact science. Nevertheless, microeconomics provides enough data to build a case for probable consumer behavior. The next chapter discusses how individual businesses use this data and its implied probabilities in their decision-making processes in order to produce profits.
Microeconomics: Factors Of Business Decision-Making
InsightsQuantity demanded describes the total amount of goods or services that consumers demand at any given point in time.
InvestingCross elasticity of demand measures the quantity demanded of one good in response to a change in price of another.
Personal FinanceMicroeconomics is the study of how individuals and businesses make decisions to maximize satisfaction. Microeconomic principles can describe many everyday experiences. We use renting a New York ...
InsightsDemand is the economic term for the cumulative wants and desires of consumers as they relate to a particular good or service. Generally speaking, if all other factors remain constant, as demand ...
InsightsElasticity measures the relationship between a good and its price based on consumer demand, consumer income, and its available supply. Learn the basics about it here.
InsightsThe concept of elasticity of demand is part of every purchase you make. Find out how it works.