Consumer Behavior

Choice and Utility• Consumer Behavior - people tend to choose those goods and services they tend

to value greatly.

Utility - SATISFACTION from consuming goods/services• Was develop to describe the way consumers choose among different consumption

possibilities. • Means how consumers rank different goods and services.• Scientific construct that economies used to understand how consumers divide

their limited resources among commodities that provide them with satisfaction

- Taste or preference and/or income affects the decision on what bundle to consume * Taste – depends on personality * Preference – Which goods provide satisfaction & how much satisfaction * Income – what bundle of goods

Marginal Utility and Law of Diminishing Marginal Utility

Marginal Utility• Denotes the additional Utility arising from

consumption of an additional unit of a commodity.• Also means “Extra”

Law of Diminishing Marginal Utility• The Amount of extra or marginal utility declines as

a persons consumes more and more of a good.

Examples:

Graphical date on Total Utility and Marginal Utility

Relationship of Total and Marginal Utility

• Total Utilities is the sum of all marginal Utilities.

• Marginal Utility –Explains the law of downward slopping demand.

History of Utility Theory• 1700 – Notion of Utility arose as basic idea of mathematical probability are being

develop

• 1738 – Daniel Bernouli (mathematician) that people are adverse to take risk and that successive new dollar of wealth bring them smaller and smaller increments of true utility.

• 1748-1831 – Jeremy Bentham – introduce utility notion into social sciences. “all

legislation should be design in utilitarian principles, to promote “the greatest happiness to the greatest number”

• 1835-1882 – William Stanley Jevons – “calculus of pleasure and pain”. Rational people would base their consumption goods on the extra or marginal utility of each good. Notion of Cardinal or measurable utility

• Today – Economies reject the notion of Cardinal Utility. “Preference” . If “A” is preferred over “B”

Equimarginal Priciple: Equal Marginal Utilities per Peso for Every Good

• States that consumer having a FIXED INCOME and facing a given market prices of goods will achieve MAXIMUM SATISFACTION or utility when the MARGINAL UTILITY of the last Peso spent on each good is EXACTLY THE SAME as the marginal utility of the last Peso spent on any other good.

• Consumer is at EQUILIBRIUM if he MAXIMIZES TOTAL UTILITY

Marginal Utility of Income – The incremental change in Utility (Satisfaction) that is due to

change of income

Why Demand Curve Slope Downward? The higher the price of a good REDUCES the consumers DESIRED CONSUMPTION of the commodity.

3 assumptions:

Completeness – Preferred, Indifferent, Less preferred

Non-Satiation – “more is better” between two bundles

Transitivity – A > B, B>C. Then, A>C

An Alternative Approach to Analysis of Demand, using the Indifference Curve1. Substitution Effect

Indifference Curve• Curve which shows DIFFERENT COMBINATIONS

of good X and Y which yield the SAME LEVEL OF UTILITY

• Any combinations that lies on the indifference curve lies the same level of utility

Marginal Rate of Substitution

• Denotes the amount of good X the consumer is willing to give up for an additional unit of good Y and still lies on SAME INDIFFERENCE curve

• Slope of indifference curve• Convex -> An individual is willing to give up

less of X for an additional of Y (DIMINISHING)

2. Income Effect

Budget line

• Shows the different combination of X and Y that a consumer can purchase for a given level of income and price.

• Shift to:– Right -> Increase in income– Left -> Decrease in income

• Leisure and the Optimal Allocation of Time: Leisure – Defines as “time which one spends as one pleases”

Principles of Consumer choice suggests that you will make the best use of your time when you equalize the marginal utilities of the last minute spent on each activity,

• Substitution Effect – Explains the downward slopping of demand curve. When the price of a good rises, consumers will tend to substitute other goods for the more expensive goods in order to satisfy their desires inexpensively.

• Income Effect – Denote that the impact of a price change on a goods quantity demanded that results from the effect of the price change on consumers real income.

From Individual to Market DemandDemand Curve for the Entire Market - obtained by SUMMING UP the quantities demanded by all the consumers.

Demand Shifts

Summary concepts of Alternative Approach

• The substitution effect occurs when a higher price leads to substitution of other goods for the good whose price has risen.

• The income effect is the change in the quantity demanded of a good because the change in its price has the effect of changing a consumers real income.

• Income elasticity is the percentage change in quantity demanded of a good divided by the percentage change in income.

• Goods are substitute if an increase in the price of one increase the demand of the other.

• Goods are complements if an increase in the price of one decreases the demand for the other.

• Goods are independent of if a price change for one has NO EFFECT on the demand for the other.

Empirical Estimates of Price and Income Elasticity’s

Importance of the use of estimates of Price Elasticities and Income Elasticities

ECONOMICS OF ADDICTION

Government should establish policies in order to minimize addiction that are hazardous to

people.

Consumer Surplus : The GAP between the TOTAL UTILITY of a good and the TOTAL MARKET VALUE

• Arises because we “receive more than what we pay for” as a result of the law of diminishing marginal utility.

• Helps the government decide. Ex: building a highway, free for all