Consumer Sovereignty

Consumer Sovereignty Andrew Trigg 2 Concepts and Feasible consumption set; budget techniques constraint Consistent preferences Slope of a line; slope of a curve; Indifference curves tangency Ordinal preferences; utility Income and substitution effects maximization Normal, inferior and Giffen goods Marginal rate of substitution Lexicographic preferences Diminishing marginal rate of Slutsky approximation substitution; convexity Revealed preference Links G This chapter shows how two of the core assumptions of neoclassical economics, methodological individualism and rationality, explored in Chapter 1, form the basis of the neoclassical theory of consumption. G The consumer demand curve forms one of the essential building blocks of the general equilibrium model. It was introduced in Chapter 1 and will be explored further in Chapter 18. G Similar techniques of maximization under constraints will be used in Chapter 5 to derive a household’s labour supply curve, and in Chapter 10 to consider how firms choose between competing techniques of production. G Alternative theories of consumption will be explored in Chapter 3. G In Chapter 4, demand curves and the Slutsky approximation are used to derive price indices and provide one measure of household welfare. 28 CONSUMPTION products that make up the modern 1 Introduction consumers’ goods economy. Here socialism, both in planning and administration, proved ‘The free enterprise economy is the true far too inflexible. One may marvel at the counterpart of democracy: it is the only attraction of often frivolous and dispensable system which gives everyone a say. Everyone consumer artifacts and entertainments in our who goes into a shop and chooses one article time, but their ultimately controlling appeal instead of another is casting a vote in the cannot be doubted.’ economic ballot box: with thousands or (Galbraith, 1992, p.7–8) millions of others that choice is signalled to production and investment and helps to An enduring image of the collapse of communism mould the world just a tiny fraction nearer to in eastern Europe was that of East Germans queuing people’s desire. In this great and continuous to cross into the west in their patched-together general election of the free economy nobody, Trabants. These 1950s style vehicles revealed how not even the poorest, is disfranchized: we are starved the East Germans had been of western all voting all the time. Socialism is designed consumption goods during the years of state on the opposite pattern: it is designed to planning. More than anything, the car has provided prevent people getting their own way, the symbol of the triumph of consumerism. For otherwise there would be no point in it.’ those on the right of the political spectrum,‘… the motor car epitomizes the freedom of private (Powell, 1969, p.33) consumers to go where they please, without relying on government, business or anyone else to run the In this quotation from the late Enoch Powell’s book buses, coaches or railways on time’ (Gabriel and Freedom and Reality, the once prominent UK Lang, 1995, p.16). In this view, the triumph of politician conveys the idea of consumer sovereignty western capitalism can be attributed more to – the idea that in a free market economy, individual Mercedes Benz and BMW than to Cruise and Trident consumers choose which goods are produced. missiles. Instead of a king, dictator or central planner making Mirroring this dominance of capitalism in the decisions, sovereignty is vested in the everyday world economy, the world’s economics profession choices of individual consumers. These individual has been dominated by neoclassical economics choices lead by an ‘invisible hand’ to the best (Chapter 1 outlined the framework of neoclassical possible outcome for the economy as a whole. economics and some alternative approaches). Although neoclassical economists vary in their Consumer sovereignty individual political allegiances, their approach has been used to provide a technical demonstration of Consumer sovereignty holds when consumers why free market capitalism offers the best system have the power to dictate what is produced in the for organizing an economy. In neoclassical economy. economics, the choices of the individual consumer are shown to determine what is produced: this is This view of the free market became increasingly what is meant by consumer sovereignty.A defining dominant with the emergence of Thatcherite and assumption of neoclassical economics is that all Reaganite policies in the early 1980s, and the individuals follow their own self-interest, whether collapse of the eastern European bloc of centrally as producers deciding which is the most profitable planned economies in the late 1980s. Indeed, it has method of production, or as consumers choosing been argued that the inability of the Soviet system to which goods to purchase. To make profits, pro- satisfy consumer demand was one of the main ducers must sell their wares. To do so, they must reasons for its demise. John Kenneth Galbraith, for produce what consumers want. The neoclassical example,has pronounced that the Soviet system: approach shows how consumer sovereignty is achieved by a market economy in which both ‘… could not satisfy the infinitely diverse and producers and consumers act according to their unstable demand for the services and self-interest. CHAPTER 2 CONSUMER SOVEREIGNTY 29 In Section 4 I look at this theory’s core assumption that consumers act according to their own preferences,like rational calculating machines,and that this gives them a full say in the ballot box of consumer democracy. I shall consider the implications of consumers either being too poor to exercise much choice in this ballot or being irrational in their behaviour. As part of this discussion, a test of the model is provided by introducing an example from experimental economics.The problem with economics,in comparison with many physical sciences,is that it is very difficult to carry out controlled experiments. A chemist can control the amount of chemicals in his measuring jar and test whether or not they will generate an explosion. Experimental economics tries to carry out its own tests by setting up arti- The sovereign consumer ficial environments in which economic behaviour can be observed. This chapter focuses on the individual consumer whose behaviour provides the key building block for the neoclassical theory of consumption.In this theory,the individual’s prefer- 2 The neoclassical theory of ences provide the basis for choosing between different goods and services. I may, for example, consumption according to my own particular tastes, prefer to buy a Top 10 CD than a record by Showaddywaddy. A schoolboy calling at the corner shop on the way It follows,since others obviously feel the same way, home from school has to decide how to allocate his that we will be prepared to pay the full price for a pocket money on crisps and chocolate; a young Top 10 CD in a Virgin Megastore, but we will only executive decides how to spend her month’s salary buy Showaddywaddy records when they are on clothes and jewellery; and Lennox Lewis, discounted for 99p in Woolworths.The point here surviving yet another challenge to his world heavy- is that my preferences drive my demand and hence weight boxing title, decides whether to spend his provide the signal in the marketplace as to what earnings on a helicopter or a yacht. prices can be charged. This relationship between Neoclassical consumer theory is based on the preferences, demand and price provides the focus assumption that, in making a comparison between of Section 2 of this chapter which demonstrates different items of consumption,individuals have pref- how the tastes and preferences of individual erences which they use to rank the possible alterna- consumers are communicated in the marketplace. tives. Assume, for example, that the schoolboy has to The rest of the chapter critically discusses the choose between two possible combinations of crisps neoclassical theory of consumer behaviour. Of and chocolate.In one shopping basket there are three particular interest is the way in which consumers packets of crisps and three bars of chocolate – this respond to changes in price. Say the price of bread can be referred to as bundle A.In the other shopping falls sharply in your supermarket.This can have two basket there are two packets of crisps and two bars of effects. It may encourage you to buy more bread chocolate,referred to as bundle B. instead of,say,potatoes;and it will also mean that you In choosing between these two bundles, the indi- are better off in real terms and can, therefore, afford vidual, in this case the schoolboy, must decide ‘Do I to buy more bread and more potatoes. Section 3 prefer bundle A to bundle B?’We use the symbol > to provides an initial analysis of these two impacts of a indicate the direction of preference: price change, using the neoclassical theory of consumer behaviour. A > B; read this as A is preferred to B. 30 CONSUMPTION Since the schoolboy likes both crisps and we can infer that they are better off with A rather chocolate,he will prefer bundle A to bundle B,and it than B, so that a policy which results in that person follows that he ranks bundle A more highly than consuming A is better than a policy that results in bundle B. The bundles are arranged in a particular them consuming B. If, however, the individual’s order, in which A is ranked higher than bundle B. choices were inconsistent then they would not Notice that we are not assuming that the individual provide a basis for assessing welfare and making places any particular absolute value on either basket, policy choices. It would be impossible to judge merely that one is valued more, or ranked higher, whether consuming A or B is the better outcome.As than the other.

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