The customer behavior concept is the study of how individuals make purchasing decisions. It assists businesses and marketers in capitalizing on these behaviors by anticipating when and how a consumer will buy a product. It aids in the identification of factors that influence these decisions, as well as the identification of ways to manipulate behavior proactively. An essential aspect for consumers when deciding on their purchase habits is the amount of their total income, and hence the limits placed on them by their financial resources (Szmigin, 2018). It is possible to optimize a series of goods and services depending on a consumer’s buying power by applying these budgetary limitations in this manner. Various types of goods may determine the consumer’s willingness to purchase the goods. These types of goods may include normal, inferior, complimentary, and substitute goods. As consumers, we must decide how to utilize the limited resources to obtain the things we want. Since one’s income determines their preference for goods and services, budget constraints heavily impact this decision. It also dictates the consumption of normal and inferior goods, which controls price and demand.
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Various economic situations influence consumers’ buying decisions, and economists may identify and anticipate consumer choice trends by understanding the link between these variables and a customer’s purchase behavior. According to economics, budget constraints are based on the assumption that a specific consumer’s spending is restricted concerning the quantity of capital they possess. Consequently, consumers consider the most advantageous strategy to leverage their buying power to maximize their utility while minimizing their opportunity costs (Kooti et al., 2016). This is accomplished via the use of budget restrictions, which indicate the feasible combinations of items or services that a customer is capable of acquiring with the money they have on hand. Identifying customer preferences is vital in understanding consumer buying patterns and the overall demand for certain products and services in a particular market or economy. An in-depth economic study of consumer behavior is necessary since customer preferences vary significantly from person to person and market to market.
The Income and Substitution Effect
Despite their diverse natures, the income impact and the substitution effect are both important economic concepts. People’s income and the price of a product may both be used to gauge both the positive and negative consequences of a change in one’s financial situation. The income effect states that if consumers have so much more income to spend, they will buy more products. A person’s normal reaction to a rise in the price of a product is to reduce their consumption of that commodity. This may happen for a variety of reasons, and both can occur at the same time.
The substitution effect happens when the price of a product increases and customers are motivated to consume less of the product and consume more the product with a lower price. According to the income effect, a higher price implies that the purchasing power of income has also been lowered (even when there is no change in the actual income), which results in consumers purchasing less of the commodity (Greenlaw & Shapiro, 2018, p.143). In contrast to the substitution effect, the income effect may be beneficial and, at the same time, negative depending on the quality of the product. The entire effect of the price shift is equal to the sum of the substitution effect and the income effect.
The Income Effect
Their income level might influence a person’s purchasing habits as consumers’ buying power increases as their income increases. Increased discretionary income provides consumers with more significant opportunities to spend their money on high-end goods and services. Consumers from lower- and middle-income groups, on the other hand, spend the majority of their money on necessities such as food and clothing. An increase or decrease in a consumer’s buying power due to a rise or fall in their actual income is known as the “income impact” in microeconomics. Increases in earnings and other forms of compensation and decreases and increases in the price of an item on which money is spent may increase available income. However, the influence does not determine the kind of things that customers will purchase. Their financial situation and preferences may acquire more costly things in smaller numbers or less expensive goods in more significant amounts.
The income impact might be either direct or indirect, depending on the circumstances. Changes in spending habits are considered “direct income effects” when they result from an increase or decrease in their income. On the other hand, when a customer is confronted with making purchasing decisions based on criteria unrelated to their income, the income impact becomes ‘indirect income effects.’ Food costs, for example, may rise, leaving consumers with less budget for other purchases. This may compel them to reduce their eating out expenses, which will have an indirect revenue impact.
People’s willingness to spend is explained by their marginal propensity to consume. Consumers’ purchasing and saving behaviors are taken into consideration in this theory. The macroeconomic theory known as Keynesian economics incorporates the concept of the “marginal propensity to consume.” The theory parallels productivity, individual income, and the propensity to spend more of it (Schettkat, 2018). According to consumer choice theory, the income effect shows how market pricing and income variations influence commodity buying behavior. Product, service, and corporate culture may all be crafted to impact purchase patterns based on consumer behavior theory. Consumer demand for regular economic products increases as actual consumer income increases (Hamilton et al., 2019). Inflation, price increases, and currency fluctuations may all have an impact on actual income. When nominal income grows without a corresponding increase in prices, this implies that consumers may acquire more items at the same price, and for the vast majority of commodities, customers will want more. It is also worth noting that as various commodities fluctuate, their buying power as a percentage of the consumer’s income changes. Growth or decline in demand for a product depends on the product’s features.
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When a person’s income rises, they tend to buy more of a commodity known as a typical good. Getting a raise (increase in income) or getting a new job that earns more money is the first step toward making more money. Secondly, a decrease in the cost of products and services may increase people’s income. While individuals are not making more money, the value of their money rises, enabling them to spend more. Products such as laptops, mobile phones, and iPods are examples of everyday products. A decrease in income (either due to a reduction in pay or an increase in prices) decreases the purchase of regular products (Victor et al., 2016). In response to a decrease in the relative price of an item, the quantity needed will increase both because the commodity is now less expensive than replacement commodities. Hence, consumers will have more purchasing power as a result of the decreased price, which will allow them to boost their overall consumption.
Inferior goods are those goods whose demand declines when real incomes increase for consumers or increases as real incomes decrease for consumers. Suppose there are more expensive substitutes for a product, the demand for such substitutes increases as the economy improves. An example of this is when a good has more expensive alternatives that experience a rise in demand due to the improvement in the economics of the society. The income elasticity of demand for low-quality commodities is negative, and the income and substitution effects act in opposing ways for these products. In response to a rise in the price of the inferior item, consumers would want to acquire other replacement goods in its place.
Consumers prefer a better-quality item; yet, they must have a higher income level to pay the higher price. Likewise, it is inferior to utilize public transit (buses and subways, which are services rather than products). People with low incomes are more likely to utilize public transportation than those with higher incomes. If a person’s financial situation improves and has more money, they are more likely to purchase a car or use a cab rather than rely on public transit. When people have less money to spend, they tend to purchase a lower quality product. Since more money is available, buyers choose to purchase a lower-quality product.
Complementary commodities are interrelated in their consumption, or, more specifically, goods that the consumer must consume simultaneously. Complimentary products are characterized by their combined demand nature, enabling interaction since consumers become desirous of purchasing a second item when the cost of the first product varies. There is a strong connection between complementary products that cannot be used independently. If one good’s price rises higher, then the demand for the other good decreases. An illustration of this would be the purchase of a vehicle and car insurance; the consumption of one necessitates the consumption of the other to function. In direct proportion to an increase in income, both of these variables will rise in value.
Perfect substitutes are items that may be used interchangeably and have no effect on the utility gained by the customer when one is substituted for another. Generally, substitutes are commodities that the customer cannot distinguish based on the need that has been satisfied and the level of satisfaction achieved. Substitutes play an essential role in the market and are widely regarded as a positive development for customers. They increase the number of options available to consumers, who can thus better meet their requirements. The cost of the goods is perhaps the most typical motivation for clients to substitute goods. Each product has a different monetary value assigned to it by the individual. As a result, while making a decision, the customer makes a choice based on their preference for one product over another. Thus, an income increase will have an interchangeable effect on the consumption of both items, leading to a rise in the amount of one or both of these goods.
The Substitution Effect
As with the income impact, the cost of items and the amount of money a customer has to spend influence their purchasing decisions. Consumers who have less buying capacity are more likely to choose lower-priced items, whereas those who have more purchasing power are more likely to choose more expensive products (Greenlaw & Shapiro, 2018, p.143). For example, a customer may decide to upgrade their pricey item rather than hold on to the earlier model because of a favorable return on an investment or other financial benefits. When a consumer’s income is on the decline, the opposite is true. As a general rule, businesses lose money when customers substitute lower-priced goods for more expensive ones.
It is also implied that consumers will have fewer alternatives available. This substitution impact is a little more involved than the replacement effect since it involves at least two things that are comparable in some manner and are of equivalent, or approximately equivalent, value to the customer. Consumers are more likely to replace the second item for the first item if the price of the first item rises while the price of the second item stays the same. This is based on the substitution effect concept. The substitution impact is frequently beneficial to retailers that offer lower-priced goods regularly. However, even a slight price drop may make a more costly product more appealing to customers since the substitution effect shifts consumption habits in favor of the more inexpensive option. Suppose private college tuition is much more than public college tuition, and a customer’s financial situation is a concern. In this case, the consumer will naturally gravitate toward public universities. However, even a minor reduction in the cost of private school tuition may be sufficient to encourage more children to enroll in private schools.
Greenlaw, S. A., & Shapiro, D., (2018). Principles of Economics-2e: OpenStax.
Hamilton, R. W., Mittal, C., Shah, A., Thompson, D. V., & Griskevicius, V. (2019). How financial constraints influence consumer behavior: An integrative framework. Journal of Consumer Psychology, 29(2), 285-305. Web.
Kooti, F., Lerman, K., Aiello, L. M., Grbovic, M., Djuric, N., & Radosavljevic, V. (2016, February). Portrait of an online shopper: Understanding and predicting consumer behavior. In Proceedings of the ninth ACM international conference on web search and data mining (pp. 205-214).
Schettkat, R. (2018). The behavioral economics of John Maynard Keynes. Econstor. eu. Web.
Szmigin, I., & Piacentini, M. (2018). Consumer Behavior. Oxford University Press.
Victor, V., Joy Thoppan, J., Jeyakumar Nathan, R., & Farkas Maria, F. (2018). Factors influencing consumer behavior and prospective purchase decisions in a dynamic pricing environment—an exploratory factor analysis approach. Social Sciences, 7(9), 153.