Lesson 10-Theory of Consumer's Behavior

transcript

THEORY OF CONSUMER BEHAVIOR

WHAT AM I THINKING WHEN I

MAKE A PURCHASE?

Objectives: At the end of the discussion the students will be able to:

study the consumption choices of people; analyze the preferences of the goods, how

higher utility satisfaction is achieved and maximized given a certain level of income;

• know the concepts of: total utility, marginal utility, and the law of diminishing marginal utility.

• understand how rational consumers compare marginal utility-to-price ratios for products in purchasing combinations of products that maximize their utility.

Outline:

The Concept of Utility-Utility-Measuring Utility- Total Utility- Marginal Utility

Law of Diminishing Marginal Utility Utility Maximization The paradox of value

Consumer Behavior and Utility Maximization

Quick write:Fill your shopping cart with all the goodsand services you plan to buy in the nexttwo months, including quantities1. What factors determine the items youplaced in your cart?2. Why does your cart contain differentitems than the person sitting next to you?3. If your income were to change in thenext six months, would your cart containdifferent items? Why or why not?4. If the price of some of the goods in yourcart were to change, would the contents ofyour cart change? Why or why not?

Theory of Consumer Behavior

Useful for understanding the demand side of the market.

Study consumer behavior to Study consumer behavior to answer:answer:

““How do consumers respond to How do consumers respond to marketing efforts the company marketing efforts the company might use?” might use?”

Consumer Buying Behavior Consumer Buying Behavior refers to the buying behavior of final consumers (individuals &

households) who buy goods and services for personal consumption.

Characteristics Affecting Consumer Behavior

BuyerBuyer

Psychological

Personal

Social

Culture

Interpersonal Determinants of Consumer Behavior* Why People Buy new Products

Factors Affecting Consumer Behavior:Culture

Social Class

• People within a social class tend to exhibit similar buying

behavior.

• Occupation

• Income

• Education

• Wealth

Social Class

• People within a social class tend to exhibit similar buying

behavior.

• Occupation

• Income

• Education

• Wealth

Most basic cause of a person's wants and behavior.

Values Perceptions

Most basic cause of a person's wants and behavior.

Values Perceptions

Subculture

• Groups of people with shared value systems based on

common life experiences.

• North Indian Consumers

• African American Consumers

• Asian American Consumers

• Mature Consumers

Subculture

• Groups of people with shared value systems based on

common life experiences.

• North Indian Consumers

• African American Consumers

• Asian American Consumers

• Mature Consumers

Factors Affecting Consumer Behavior:Social

Groups

• Membership

• Reference

Groups

• Membership

• Reference

Family• Husband, wife, kids• Influencer, buyer,

Roles and StatusRoles and Status

Social FactorsSocial Factors

Factors Affecting Consumer Behavior:Personal

Personal InfluencesPersonal Influences

Age and Family Life CycleStage

Age and Family Life CycleStage OccupationOccupation

Economic SituationEconomic Situation

Lifestyle IdentificationLifestyle Identification

ActivitiesActivities OpinionsOpinions

InterestsInterests

Personality & Self-ConceptPersonality & Self-Concept

Personal Determinants of Consumer Behavior

Needs and Motives Need: an imbalance between a

consumer’s actual and desired states

Motives: inner states that direct a person

toward the goal of satisfying a felt need

UTILITY THEORY . . .

What comes to your mind when you hear the word - UTILITY?

UTILITY is…

Dictionary defines UTILITY as usefulness, service, value, worth or benefit

In Economics, UTILITY means the benefit or satisfaction that aperson gets from the consumption of a good or service.

UTILITY is the basis of choice

The concept of utility helps us make predictions about consumption choices.

CAN YOUR SATISFACTION BE

MEASURED?

Jollibee’s sausage-egg Pandesal Meal

Mcdonald’s Sausage-egg Pandesal meal

The theory faces 2 major problems

1. It is impossible to MEASURE satisfaction or utility

I CAN GET NO SATISFACTION…BUT I TRY, AND I TRY…

2. It is impossible to COMPARE the satisfaction or utilities of two persons or among individuals

There is a way in Economics that will quantify or measure utility or satisfaction through the concept of UTIL

UTIL is an artificial construct or arbitrary number used to measure utility or satisfaction

Measuring Utility (Utility Cocepts)

Cardinal Utility Approach- refers to the measurement of utility

by assigning numerical values, referred to as utils, such as 1 util, 12 utils, 140 utils or -35 utils.

- assumes that we can assign values for utility, (Jevons, Walras, and Marshall). E.g., derive 100 utils from eating a slice of pizza

- attaches specific numbers to different levels of satisfaction

Ordinal Utility Approach- measures utility in terms

of ranks, such as those indicating levels from most satisfying to least satisfying, best to worst, and highest to lowest.

-does not assign values, instead works with a ranking of preferences (ordinal ranking preferences) (Pareto, Hicks, Slutsky)

EXAMPLE …

What did you eat for breakfast?

30 utils 20 utils 50 utils

This just shows that one can ASSIGN a number of UTILs to each GOOD.

This is a subjective value because it depends on the person’s level of

SATISFACTION derived from CONSUMING a GOOD.

THE CONCEPT OF UTILITY

The concept of utility helps us to make predictions about consumption choices.

But Marginal Utility Theory is NOT as precise as the concept of Utility.

TOTAL VS. MARGINAL UTILITY

TOTAL UTILITY – The TOTAL satisfaction a person receives from consuming a particular quantity of a good

MARGINAL UTILITY – The ADDITIONAL utility a person receives from consuming an extra unit of a particular good. TU

TOTAL UTILITY

Depends on the quantity of the good consumed – more consumption generally gives more total utility.

Total utility generally increases as the quantity consumed of a good increases.

Q TU MU

0 0 ---

1 20 20

2 27 7

3 32 5

4 35 3

5 35 0

6 34 -1

7 36 -4

Example (Table 4.1):

Total utility and marginal utility

TU, in general, increases with Q

At some point, TU can start falling with Q (see Q = 6)

If TU is increasing, MU > 0 From Q = 1 onwards, MU is

declining principle of diminishing marginal utility As more and more of a good are consumed, the process of consumption will (at some point) yield smaller and smaller additions to utility

Q TU MU

0 0 ---

1 20 20

2 27 7

3 32 5

4 35 3

5 35 0

6 34 -1

Example (Table 4.1):

TU2 – TU1 = MU1 (extra utils derived from consuming one more cup of coffee

CUPS OF COFFEE

TOTAL UTILITY

MARGINAL UTILITY

TU2 10

TU2 – TU1 = MU1 (extra utils derived from consuming one more cup of coffee

CUPS OF COFFEE

TOTAL UTILITY

MARGINAL UTILITY

TU2 10

10 - 0= 10

19 - 10= 9

27 – 19 = 8

34 – 27 = 7

40 – 34 = 6

LET’S FOCUS ON THE MARGINAL UTILITY OF COFFEE…

MARGINAL UTILITY

10 - 0= 10

19 - 10= 9

27 – 19 = 8

34 – 27 = 7

40 – 34 = 6

THE MARGINAL UTILITY DECREASES AS MORE CUPS OF COFFE IS CONSUMED

OR THE UTILITY IS DIMINISHING OR DECREASING

THIS IS CALLED…LAW OF DIMINISHING MARGINAL UTILITY

DIMINISHING MARGINAL UTILITY

=The general tendency of marginal utility to decrease as the quantity of a good consumed increases.

The law of diminishing marginal utility

The gains in satisfaction will decline as successive

units of a given product are consume

: Consumers will buy as much as pleases them, with their income. As each additional unit is purchased, the excess satisfaction gained from each purchase decreases, until it becomes irrational to continue purchasing.

. For example, one slice of pizza may give you much satisfaction, as does the second slice. The third slice makes you extremely full, while the fourth slice makes you nauseous. At this point, it becomes irrational for you to purchase additional slices of pizza.

Total Utility Curve

0 1 2 3 4 5 6Quantity

tility

Figure 4.1

1 2 3 4 5 6

Quantity

l util

Figure 4.2

Marginal Utility Curve

WHY DEMAND CURVE IS DOWNWARD SLOPING

One of the reasons is the LAW OF DIMINISHING MARGINAL UTILITY

The inverse relationship of price and quantity demanded is partly explained by the law of diminishing marginal utility.

As one consumes successive units of a specific good, the less will be the utility it can give. Therefore, since this will give lower utilities, the price of the good must decrease.

DEMAND CURVE…once again!

I will only buy more units of the good if you will give me a discount! Or make the good cheap so that I can buy large quantities of the good.

Since the satisfaction I get from consuming extra units of good decreases, I will only buy the good at a lower price!

Consumer Equilibrium

So far, we have assumed that any amount of goods and services are always available for consumption

In reality, consumers face constraints (income and prices):Limited consumers income or

budgetGoods can be obtained at a price

WHO IS THE CONSUMER?

RATIONAL – wants to get the most for his money or maximize total utility

PREFERENCES – desires certain goods Clear cut preference for goods and services. Buyers have a good idea of how much marginal utility they may have in successive units of the various products they might purchase.

BUDGET CONSTRAINT - faces budget limitation because of limited money income

PRICES – considers the prices of goods

Consumer Behavior and Utility Maximization

An economic explanation for how different consumers allocate theirmoney income among different goods and services:· rational behavior:· preferences:· budget constraint:· prices:Consumers try to get the "most for their money" to maximize their

total utilityConsumers have clear cut preferences and can determine how much

marginalutility they get from consuming more units of a productAll consumers face a budget constraint, therefore must make decisions

about what they buy based on their limited budgetEvery product has a price, so consumers must weigh their purchasing

decisions based on their marginal utility from consumption and the price of the goods they consume

The goal of a consumer is to maximize satisfaction or utility given the limited income.

This is accomplished by applying the marginal utility concept.

Given the limited income and the prices of goods, the consumer would want to obtain the highest utility possible.

Maximizing Total Utility

Utility Maximizing Rule:-The rule that leads to the greatest total utility from all the goods and services consumed. The rule is:

1.Allocate the entire available budget.

2.Make the Marginal utility per peso spent the same for all goods.

Some simplifying assumptions

Consumer’s objective: to maximize his/her utility subject to income constraint

2 goods (X, Y) Prices Px, Py are fixedConsumer’s income (I) is

Marginal utility per peso additional utility derived from spending the next peso on the good

MU per peso MU

Optimizing condition:

spend more on good X and less of Y

Efficiency, Price, and Value

Marginal Utility theory helps us to deepen our understanding of the concept of efficiency and to see more clearly the distinction between value and price. Let’s see how . . .

Utility Maximization Rule:to maximize satisfaction, a

consumer should allocate his or her

money income so that the last peso spent on each product yields

the same amount of extra utility. Marginal Utility per peso should be

equal for each product you buy!

Simple Illustration

Suppose: X = fishball Y = siomai

Assume: PX = 2 PY = 10

Numerical Illustration

Qx TUX MUX MUxPx

QY TUY MUY MUyPy

1 30 30 15 1 50 50 5

2 39 9 4.5 2 105 55 5.5

3 45 6 3 3 148 43 4.3

4 50 5 2.5 4 178 30 3

5 54 4 2 5 198 20 2

6 56 2 1 6 213 15 1.5

2 potential optimum positionsCombination A: X = 3 and Y

= 4TU = TUX + TUY = 45 + 178 = 223

Combination B: X = 5 and Y = 5TU = TUX + TUY = 54 + 198 = 252

Presence of 2 potential equilibrium positions suggests that we need to consider income. To do so let us examine how much each consumer spends for each combination.

Expenditure per combination Total expenditure = PX X + PY Y Combination A: 3(2) + 4(10) = 46 Combination B: 5(2) + 5(10) = 60

Scenarios:If consumer’s income = 46,

then the optimum is given by combination A. .…Combination B is not affordable

If the consumer’s income = 60, then the optimum is given by Combination B….Combination A is affordable but it yields a lower level of utility

The Paradox of Value

More than two centuries ago, in The Wealth of Nations, Adam Smith posed the paradox of value:

“Nothing is more useful than water; but it will scarce purchase anything. A diamond on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.”

Why water is vital is cheap while diamonds are relatively useless but expensive.

The more there is of a commodity, the less is the relative desirability of its last little unit. It is therefore clear why water has a low price and why an absolute necessity like air become a free good. In both cases, it is the large quantities that pull the marginal utilities so far down and thus reduce the prices of these vital commodities.

Water is more valuable than a diamond because water is more essential to life itself. Yet water is much cheaper than a diamond. Why?

Adam Smith tried to solve this paradox, but it was not until marginal utility theory had been developed that anyone give satisfactory answer.

Consumer Surplus

The paradox of value emphasizes that the recorded monetary value of a good may be a misleading indicator of the total economic value of that good. The measured economic value of the air we breathe is zero, yet air’s contribution to welfare is immeasurably large.

The gap between the total utility of a good and its total market value is called consumer surplus. The surplus that arises because we “receive more than we pay for” as a result of the law of diminishing marginal utility.

We have consumer surplus basically because we pay for the same amount for each unit of a commodity that we buy, from the first to the last.

Activity:

Answer the following questions briefly:1. Do we always have limitations in

consuming goods? Defend your answer.2. Why do people go for more expensive

goods rather than cheaper goods?3. When you get stranded in a desert for a

long time, which do you think has more value, water or diamond? Discuss your answer.

4. 4. Why is it necessary for us to spend our budget wisely?

HAVE A BLESSED DAY!

Lesson 10-Theory of Consumer's Behavior

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