You may have heard the term consumer sovereignty get thrown around a few times on the news on CNBC or Bloomberg or other business news channels when they were talking about the financial strategies and decisions of businesses. It may have led you to ask yourself “What is consumer sovereignty?” and “Why is consumer sovereignty so important?” Consumer sovereignty refers to the power of consumers to decide what goods and services are produced and how scarce resources are allocated. Thus, if consumers demand more of a good or service in the marketplace, then more will be supplied.
It All Starts with Capitalism
Consumer sovereignty is one of the hallmarks of capitalism. To understand the concept of consumer sovereignty, you need to understand capitalism.
Capitalism is an economic system that is characterized by the private ownership of capital goods. In a capitalist system, goods and services are produced based on the forces of supply and demand in the market. Capitalism is the extreme opposite of central planning, where the government makes major decisions about what to produce. Pure capitalism is on one extreme and pure communism or socialism, both characterized by varying degrees of central planning, are on the other extreme. In the middle are different intensities of mixed capitalism.
The Factors of Production
In any economy, no matter what the economic system, there are three factors of production: land, labor and capital.
Land: Land refers to the earth, real estate and so on. Because the planet has limited space, this resource is limited as well. With growing populations and the increasing utilization of the land beneath our feet, the land becomes more precious with time. It is the canvas upon which production occurs. Land yields rent.
Labor: Labor is the energy and effort supplied by human beings. This resource is only limited by the number of able humans available. As populations grow, labor becomes more abundant. Because of how naturally abundant it is, labor is the least paid of the factors of production. Labor yields wages.
Capital: Capital is a little harder to define than the other two factors of production. Capital can refer to the machinery used in production, the information that facilitates and improves production or even the money or influence that is used to finance production. Capitalism originally comes from the Latin word “capitalis” which, translated literally, means “heads of cattle.” In the past, this was a reference to the quantity of livestock owned by an individual as it correlates to his wealth. Capital is therefore about the resources we control that are neither land nor labor that we can use in production. The universal symbol of capital, of course, is money. Capital yields profits.
With these three factors of production, an economy, through its economic system, will seek to resolve the problem of scarcity. That’s the whole basis of economics; every society faces scarcity in its resources. If resources were infinite, there wouldn’t be a need for any economic systems because everyone could have everything they wanted and we would be living in heaven on Earth. Everyone's needs and wants would all be met, and they would be in a constant state of bliss. But this isn’t the case, unfortunately, and so scarcity is something we have to deal with on a daily basis. Because of scarcity, needs and wants aren’t always met.
Three Economic Questions
One of the by-products of scarcity is that it forces us to make choices. We have to choose between alternatives based on their relative merit to our welfare. These choices can be anything. However, in the world of economics, these choices are about how we’re going to use the factors of production, which are limited, to achieve our goals. That leads to three economic questions that should be answered by any society.
What to Produce?
The factors of production themselves are scarce, and so we should determine what to produce with them, and in what quantities. The more we produce of one thing with the available resources, the less we can produce of something else. All these varying mixes of quantities can be plotted along something called a production possibilities curve, which shows us how, as the quantities of one good increase, the quantities of other goods decrease along a curve. This is because the same resources are used to produce everything, and so we must always make a choice about what to produce.
How to Produce?
How to produce is a much more technical question. The resources are scarce, so we should look for the most efficient methods of production to utilize these resources in the best way possible. Efficiency means producing the most with the least amount of resources. These resources are always a mix of labor, capital and land. On the one hand, we have technical efficiency, which looks at the costs of the inputs and looks for the cheapest inputs. On the other hand, we have economic efficiency, which affects the combined value of the inputs and how they maximize the value of the output. Sometimes paying a little more for the inputs can lead to a massive increase in the value of the output.
For Whom to Produce?
Once the society has figured out what it wants to produce and how to produce it, it should decide how to distribute those goods and services to the population. The question of whom to produce for is where the question of consumer sovereignty pops up.
The Concept of Consumer Sovereignty
Consumer sovereignty is the ability and freedom of consumers to decide which goods and services from a wide variety available are right for them and to choose whatever works for them. The idea behind consumer sovereignty is that consumers are the captains of a capitalist society. Their preferences are what decide how the three fundamental economic questions will be answered.
According to the theory of consumer sovereignty, consumers will choose between different goods and services, and the services and suppliers behind them at their discretion. They will go for the least expensive goods and services that offer the best quality because they are rational human beings who know what they want. They are sovereigns or kings and queens of their own private lives. It is consumer sovereignty that ensures that a free market functions effectively and efficiently, since it rewards the firms that are efficient and who can provide the goods that the consumer wants.
The consumer will tell producers which goods and services he or she prefers via the price mechanism. Because there is naturally a scarcity of resources, not all the wants of the consumer can be fulfilled. The consumer will, therefore, be faced with choices to make between a large variety of goods and services that are available from different producers.
Some desires of the consumer will be greater and more urgent than others. The consumer will, therefore, be prepared to pay a higher price for these goods and services. That means that the producers of those goods and services will make a higher profit. If the consumer’s desire for a particular good or service isn’t as great or as urgent, then that consumer will not want to spend a lot of money on it and will offer a lower price. Producers of these goods and services will experience less profit than producers of the goods and services that have greater demand. Because producers have an incentive for profit, they will naturally produce more of the goods that are in demand by consumers.
On the other hand, the supply of a product may also have an effect on the value placed by the consumer on that good. When a good or service that already has a low value in the eyes of the consumer is produced in high supply, then the consumer will want to pay even lower prices for that good or service. Alternatively, if the producer limits the supply of that good or service, due to its low demand, then its comparative value in the eyes of the consumer will be raised, and the consumer will be willing to pay a higher price.
The prices of goods and services in a free market are therefore a measure of the relative values of those goods and services in the eyes of the consumer.
The tastes and preferences of the consumer do not remain constant and fluctuate with time and circumstance, which means that the prices of commodities will not remain constant but will rise and fall based on the change in their perceived value and consumers’ changing tastes and preferences. Consequently, a producer must constantly alter production – what they produce and in what quantities – to match the changing patterns of demand and supply in the market.
Producer sovereignty is the opposite of consumer sovereignty and is when firms can influence the decisions consumers make about what to buy. A good example of a system where producer sovereignty works are in a monopoly. In a monopoly, consumers have to pay the price set by firms for their goods and services because they do not have options. Also, in a more competitive market, psychologically persuasive advertising techniques used by producers can influence what consumers buy.
Apple Case Study
Steve Jobs is famously known for arguing that asking customers what they want and going to build it was not an effective way to make a profit. He claimed that customer tastes and preferences are fickle. By the time you’re done building what the consumer said they wanted, they would want something else. Instead, according to Jobs, a firm should be able to anticipate what a consumer will want in the future and go ahead and build it. It requires a lot of innovation to come up with something new that consumers will like and didn’t know that they would like. For this reason, Apple has been a leader in the technology sector for close to a decade.
Facebook Case Study
The social media giant Facebook is built around its ability to deliver regular dopamine hits to its consumers. According to the former vice president for user growth at Facebook, Chamath Palihapitiya, Facebook gets people addicted and influences them to spend more time on the network, harvesting their information, in turn, to sell to advertisers for a profit. Facebook is an example of how a company can influence the decisions made by customers by first getting them addicted to a product and then using that product to shape their perspectives and decisions.
Google Case Study
Google is an example of a near-perfect monopoly. According to Statcounter.com, Google currently owns 93 percent of the global search engine market. Customers tend to divide themselves along the lines of brand loyalty and, if they feel like their current brand is meeting all of their needs and wants, they feel no need to switch to a different brand or even consider different brands. Google, therefore, has near absolute producer sovereignty in the search engine market and can drive the changes and products they want in the market.
Trip Advisor Case Study
Bringing customer reviews to the digital world has not only improved consumer sovereignty but has drastically revolutionized it. Customers can now easily share bad experiences at hotels and other places on Trip Advisor, giving them the power to build or break the reputation of a business. Some customers can use the threat of a bad review to receive favors and refunds that would otherwise have been unavailable to them.
The real world is a mix of both producer and consumer sovereignty. There are a variety of factors which determine which will prevail in a particular situation. The structure of the market that is whether it is a monopoly or not, the industry in which it is dealing, considerations of behavioral economics and the influence of the internet are just some of the many factors to consider.
Ultimately, a healthy mix of producer and consumer sovereignty is good for a healthy economy where consumers can choose what they like, and producers can anticipate what consumers will like and deliver it to them at the best price.
- Opinion Front: Consumer Sovereignty: What are its Benefits and Limitations?
- Investopedia: Capitalism
- Vision: Adam Smith: Capitalism’s Founding Father
- CSTL-HCB: The Three Basic Economic Questions
- The Institute for Faith, Work & Economics: Four Essential Elements of Economic Progress
- Economics Help: Producer and Consumer Sovereignty
Nicky is a business writer with nearly two decades of hands-on and publishing experience. She's been published in several business publications, including The Employment Times and Business Idea Factory. She also studied business in college.