Consumer sovereignty

Consumer sovereignty is an economic concept where the consumer has some controlling power over goods that are produced, and the idea that the consumer is the best judge of their own welfare.

Consumer sovereignty in production is the controlling power of consumers, versus the holders of scarce resources, in what final products should be produced from these resources. It is sometimes used as a hypothesis that the production of goods and services is determined by the consumers' demand (rather than, say, by capital owners or producers).

Consumer sovereignty in welfare is the idea that the consumer is the best judge of their own welfare (rather than, say, politicians). It is used to claim that, for example, the government should help the poor by giving them monetary transfers, rather than by giving them products that are deemed "essential" by the politicians.

Consumer sovereignty in production

Consumer sovereignty was first defined by William Harold Hutt as follows:

The consumer is sovereign when, in his role of citizen, he has not delegated to political institutions for authoritarian use the power which he can exercise socially through his power to demand (or refrain from demanding).

The double use of the word "power" in this definition makes it clear that the power of the consumers was the most important topic in the whole concept. Hutt later reformulated the definition in a similar sense:

...the controlling power exercised by free individuals, in choosing between ends, over the custodians of the community's resources, when the resources by which those ends can be served are scarce.

Examples

Sometimes a business will fail because they can’t provide the products necessary to make consumers happy.

• Blockbuster ultimately failed because consumers started to adapt to more convenient alternatives like Netflix, Redbox and video on demand. Blockbuster continued renting out DVDs and VHS tapes at traditional stores and were slow to modernize, causing Blockbuster to lose money and eventually go bankrupt.
• Dell, once the biggest computer manufacturer, faltered as mobile devices began to displace PCs, cheap Asian machines cut into profitability, and big customers began to demand end-to-end service in addition to the hardware.
• Kodak is an example of how a business can fail because it doesn’t meet the needs of consumers. When other companies (such as Nikon and Canon) began making cameras that took digital photos unlike the film cameras from Kodak, consumers switched to these companies and eventually, Eastman Kodak went under.

Consumer sovereignty has had a positive and negative impact on society because it has helped businesses increase their profit and market value, but has also led to the shutdown of various companies which couldn't provide the consumers with the goods they demanded.

Origins

The idea of primacy of consumption over production was first pronounced by Adam Smith in 1776:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer.

The term "consumer sovereignty" was first coined by William Harold Hutt in his book Economists and the Public: A Study of Competition and Opinion (1936). However, Hutt himself was always cautious of claiming credit for the term:

I am not sure whether I coined the term myself. Marketing literature contains phrases like "the customer is always right", and I am told that a proverbial expression in High Dutch is "De klant is koning" (the customer is king). I first used the term in its present sense in an unpublished article which I circulated in 1931. It first appeared in print, I believe, in an article which I published in March 1934. In 1935 Dr. W. Röpke used the phrase "democracy of the consumers"; and in the same year Professor F. A. Hayek used the phrase "sovereignty of the consumer" in a section heading in Collectivist Economic Planning. Since then the term seems to have been fairly widely employed.

Although Hutt did not mean to establish any theory based on this concept, it is argued by some economists that the consumer sovereignty does not hold in some cases, for example, in healthcare.

When the term was used for the first time by Hutt, it was written as "consumers' sovereignty". In the book's review by Jacob Viner, he used it as "consumer's sovereignty". Later, the use of the term "consumer sovereignty" became generally used.

Consumers versus suppliers

For the consumer sovereignty it is very important how the consumers and their demand is understood. In this concept, everyone is a consumer and has their demand not only for products such as food, or commodities as oil or gas, but also for production factors such as time, and all other possible things. When a worker wants to have more leisure time, his demand for leisure is confronted with the demand of the society for his work. Only after the worker outbids the society for his leisure, he can consume it as he wishes. According to Hutt, the poor understanding of the consumers and their demand has led to some of the early criticisms of this concept:

It seems to me that one basic misunderstanding is mainly responsible for all Professor Fraser's criticisms. He says that the "doctrine of consumers' sovereignty implies, perhaps even entails, that preferences on the side of demand are fundamentally and in principle more important than those on the side of supply." But all I have done is to make the concept correspond with the distinction between ends and means. As I have used the term, it covers the expression of all human preferences in respect of ends, in so far as those ends are confronted with scarce means. When ends are being sought, we are concerned with demand; when means are being chosen, we are concerned with an aspect of supply- entrepreneurship.

As Hutt also described, the concept therefore does not neglect the suppliers:

This does not involve any "startling neglect," as Professor Fraser describes it, "of the producers' side of the picture." Every owner of resources (including his own physical powers) may be regarded as bidding, with the rest of the consumers, for the services of his own resources. We may regard him as normally offering part of those services for exchange, actual or anticipated bidding as a whole. He is, so to speak, outbid for such services by other consumers.

Criticism

The concept has been criticized since it has been published in Economists and the Public: A Study of Competition and Opinion (1936), often the essence was the understanding of the concept in which Hutt did not manage to respect the symmetry between freedom to demand and freedom to supply. Although Hutt may be blamed for the misunderstanding of the critics, they have missed the point of the concept:

Recognizing that in some situations a producer might choose a less remunerative activity which that producer finds more personally satisfying, Hutt defined such a decision as one of consumption, not production. In doing so, he attempted to force the distinction between consumption and production to run exactly parallel to the distinction between ends and means.

The effort to make distinction between consumption and production parallel to the distinction between ends and means was viewed as unfortunate wordplay exercise by some economists.

Even if consumers are approached traditionally, they are largely sovereign under the assumption that in the role of producers, people maximize their income. This hypothesis has been discussed by economists often and is also addressed as consumer sovereignty.

This element supports society because consumers have the power to decide how a store is going to function and go up or down in sales, simply by buying things, they are deciding what goods are produced and how it will sell, and if it brings consumers back to the market and if new consumers will visit. It also brings competition between other markets because other markets might need to change the price on their goods in order to bring consumers back.

Related concepts

• Dollar voting is the impact of consumer choice on producers' actions through the flow of consumer payments to producers for their goods and services.
• Ethical consumerism is a process by which consumers deliberately try to influence the production process according to their moral values, for example by preferring ethical producers or boycotting non-ethical ones.
• Resource dependence theory is the theory that production depends on resources available from the environment, rather than just on consumers' demand.

Consumer sovereignty in welfare

Consumer sovereignty is defined in the Macmillan dictionary of modern economics as:

Consumer sovereignty. The idea that the consumer is the best judge of his or her own welfare. This assumption underlies the theory of consumer behaviour and through it the bulk of economic analysis including the most widely accepted optimum in welfare economics, the Pareto optimum.

A more detailed definition was given by Abba Lerner:

The basic idea of consumer sovereignty is really very simple: arrange for everybody to have what he prefers whenever this does not involve any extra sacrifice for anybody else. … One of the deepest scars of my early youth was etched when my teacher told me, “You do not want that,” after I had told her that I did. I would not have been so upset if she had said that I could not have it, whatever it was, or that it was very wicked of me to want it. What rankled was the denial of my personality—a kind of rape of my integrity. I confess I still find a similar rising of my hackles when I hear people's preferences dismissed as not genuine, because influenced or even created by advertising, and somebody else telling them what they “really want.”

Empirical evidence

A possible way to test the consumer sovereignty assumption is to compare consumers' valuations to items they purchase on their own, to their valuations to items they receive as gifts from friends and family. In one such experiment, done during a holiday season, it was found that consumers value their own purchases about 18% more than the gifts they receive. This supports the consumer sovereignty assumption.

Another experiment compared the effects of two parallel government programs in Mexico, both intended to help poor villages: the first provided cash transfers, and the second provided food transfers. The experiment found no evidence for the "paternalistic" view that in-kind transfers are better and that cash transfers induces consumption of unhealthy products. Since cash transfers are cheaper to carry out, a practical conclusion of this experiment is that it is better to help the poor by giving them cash transfers that they can use according to their subjective preferences.

Criticism

J. K. Galbraith claims that advertising distorts consumers' preferences, so consumers' revealed preferences actually represent what is good for the advertisers and not what is good for consumers themselves.

Lester Thurow claims that many consumers (e.g. children and drug-addicts) are incompetent of knowing that is good for them. Moreover, even competent individuals have preferences that are partly influenced by society, and do not represent only their own wants.

Various studies show that consumers' preferences are irrational and inconsistent, and so they cannot represent what is actually good for them. This is true, in particular, for inter-temporal decisions (such as deciding how much to save for old age) and probabilistic decisions (such as assessing the risks of financial investments).

A practical implication of such criticisms is that governments should provide merit goods rather than lump-sum transfers.

Further reading

• Campbell R. McConnell and Stanley L. Brue (1999), Economics (14th ed.). McGraw-Hill.
• Kenny LJ (8 March 2019). "The citizens know their own utility functions better than the politicians". Economics Stack Exchange. Retrieved 6 June 2019.