Understanding Consumer Sovereignty

The idea that consumers influence production decisions is called consumer sovereignty. Consumers effectively “vote” for the goods they want with their spending power, causing firms to respond to consumer preferences and produce the goods they demand. Consumer sovereignty is a manifestation of the so-called “invisible hand.”

However, some argue that the idea of consumer sovereignty is no more than a myth. They believe that firms produce goods and use marketing techniques to sell those goods to consumers, even when the goods produced are ones that consumers don’t necessarily want or need.

In practice, both of these perspectives have a point. For example, firms may successfully market new goods–think of the new generation of iPhone that comes out every year. But if consumers aren’t impressed with these new goods, they won’t sell. This is reflected in the countless new products that are released each year but never take off in sales.

Free Markets and Consumer Sovereignty

• Consumers have higher levels of consumer sovereignty in a free market.

• There is no consumer sovereignty in command economies, where goods are produced according to state dictations.

Healthcare and Consumer Sovereignty

A lack of knowledge makes it more difficult to cater to consumer sovereignty in some markets. For example, doctors seldom offer patients meaningful choices; instead, they use their own knowledge to prescribe various treatments and medications. In addition, patients typically do not get to choose between various hospitals and medical providers. Instead, they go to the ones that are provided by the state or covered by private insurance plans.

In theory, consumers do have a degree of choice in this market. But in practice, it is very different–choosing a doctor, hospital, or medication is very different from selecting a meal to eat.

Behavioral Economics and Consumer Sovereignty

In traditional economic theory, it’s assumed that consumers are looking to maximize utility. Furthermore, the equimarginal principle states that consumers choose a combination of goods that maximize total utility by weighing the marginal benefit of a variety of choices.

Behavioral economics, however, suggests that this model is not realistic. In theory it may work, but in practice, people generally do not have the time or the desire to rationally weigh various options against each other. Instead, they often use heuristics and rules of thumb to make rapid decisions. Plus, psychological factors have a huge influence on consumers as well. These psychological factors include:

• Choice architecture, or the strategic placement of goods by firms. This can influence consumers’ decisions greatly. For example, most consumers are more likely to select the default option than to go through the effort of making a change. Firms oftentimes use this strategy to lead consumers to sign up for insurance or newsletters.

• Loss aversion, or the tendency to avoid losses. This also has a huge impact on consumers. People generally dislike losing the things they have, so they’ll go to great lengths in order to avoid losses.

• Nudges, or subtle encouragements to buy what is suggested. These can easily convince consumers to buy more. For example, think of going to a fast-food restaurant. The simple questions, “Would you like fries with that?” and “Would you like to supersize that?” encourage consumers to add to their original purchase.