6: Consumer Behaviour
Consumer Behaviour
6.1 Marginal Utility and Consumer Choice
Consumer Decisions:
Consumers choose between various goods and services (coffee, movies, mobile devices, etc.).
Motivation is to maximize utility, defined as the total satisfaction from consumed goods and services.
Utility Concepts:
Utility: Satisfaction received from consuming goods and services.
Total Utility: Overall satisfaction from consuming a given product.
Marginal Utility: Additional satisfaction gained from consuming one more unit.
Example: Total utility from five bottles of juice versus marginal utility of the fifth bottle.
Diminishing Marginal Utility:
As consumption of a product increases, the utility derived from additional units decreases.
Illustrated with the example of water consumption, which demonstrates high initial value followed by decreasing value as consumption continues.
Utility Schedules and Graphs
Utility Measurement:
Assumption: Utility can be quantified (measured in “utils”).
Example: Alison’s daily consumption of juice highlights how total utility increases but marginal utility decreases with each additional bottle.
Marginal Utility Calculation:
Total utility increases from consuming juice (e.g., from 30
down to 99 utils) while marginal utility decreases (20 down to around 1).
Maximizing Utility
Utility-Maximizing Consumers:
Consumers aim to maximize total utility while facing constraints (income, product prices).
Maximizing Decision Process:
For two goods (e.g., juice and burritos), optimal consumption is reached when:
\frac{MU{juice}}{P{juice}} = \frac{MU{burritos}}{P{burritos}}Example: If the marginal utility from juice is three times that from burritos, shifting expenditure towards juice increases overall satisfaction.
Fundamental Equation of Marginal Utility Theory:
MU{X} P{X} = MU{Y} P{Y}
A utility-maximizing consumer allocates expenditures equally across products based on marginal utility per dollar spent.
6.2 Income and Substitution Effects of Price Changes
Understanding Consumer Responses to Price Changes:
Price changes lead to income effects and substitution effects.
Substitution Effect:
When the price of a product decreases, consumers substitute away from other goods to purchase more of the product.
Income Effect:
A price decrease increases real purchasing power, leading consumers to buy more of normal goods. Example with Tristan and ice cream.
Combined Effects
Total Quantity Demanded:
A combination of substitution and income effects results in increased quantity demanded for goods whose prices have fallen, reinforcing the negatively sloped demand curve theory.
Example Illustration:
Discusses a price drop's effect on Tristan's purchasing decision for ice cream, demonstrating both effects.
Giffen Goods
Overview:
Rare occurrences where an increase in price leads to a higher quantity demanded, characterized by inferior goods and significant income effects.
Example of Giffen behavior involving bread and the working class in the 19th century.
6.3 Consumer Surplus
Definition:
Consumer surplus is the difference between the total value consumers place on a product and what they actually pay.
It represents the economic benefit consumers receive over the market price they pay.
Illustration of Consumer Surplus:
Example with Moira and Milk:
Willingness to pay for successive liters of milk demonstrates how consumer surplus is accumulated based on demand.
When the price is below her willingness to pay, the surplus is calculated as the area under the demand curve above the price line.
Paradox of Value
Discussion:
The fundamental question of why essentials (like water) can have low prices compared to luxurious items (like diamonds).
Resolution through marginal utility theory explains how low price correlates with high total utility yet low marginal utility, and vice versa for diamonds.
Summary
Key insights on marginal utility theory, consumer decision-making, income and substitution effects, Giffen goods, and consumer surplus were explored.
Creating a model of all consumers starts with applying broad variables on a group of people.
Concept of Utility
Utility: the satisfaction or wellbeing that a consumer receives from consuming some good or service. Measured in a unit “utils”
Total utility: the total satisfaction resulting from the consumption of a given commodity by a consumer.
Marginal utility: the additional satisfaction obtained by the consumer from consuming one additional unit of the commodity.
Consumers want to maximize the amount of satisfaction they have.
Utility schedule: a table showing the relationship between quantity demanded, total utility and marginal utility of a particular commodity.
Calculating marginal utility: slope equation → Tu1 - Tu0 / Q1 - Q0
Satisfaction is gained at a diminishing rate. → the law of diminishing marginal utility.
The utility that any consumer derives from successive units of a particular product consumed over some period of time diminishes as total consumption increases.
Traditional definition of scarcity violates the law of diminishing marginal utility.
At the local maximum: point of statiation. The marginal utility here becomes 0. Applies even for money — it becomes a hinderance.
Cardinal utility: measurement of utility in absolute terms. (problematic.)
Ordinal utility: measurement of utility in relative terms (the ranking of different bundles of goods) → 1 coke is preferred to 1 apple which is preferred to 1 turkey leg. Rank them from most to least preferred.
For my paper: the greatest utility from a small, monthly payment.
Maximizing utility: every consumer attempts to make themselves as well off as they possibly can in the circumstances they find themselves in. Maximized utility occurs at the utility maximization condition. AKA consumer equilibrium.
MU,x / Px = MU,y / Py
Allocating expenditures so that the utility obtained from the last dollar spent on each product is equal.
Mu,x/MU,y = Px / Py → Px / Py is called the relative price. You must compare it to something.
The ratio of marginal utilities is the relative marginal utility.
Point of statiation
Budget lines: shows alternative combination of goods purchased by a consumer with a given income facing given prices.
The slope of a budget line is the relative price → px/py.
Indifference curve: shows alternate combinations of two products, each of which gives that same utility or satisfaction
Each line represents an amount of total satisfaction.
A mapping from the origin of various total utilities.
Money is spent in such a way that utility is maximized.
Indifference is when bundles are on the same line.
Now, superimpose the indifference curves onto the budget line. There is one line that is tangent to the budget line. This tangent point is the utility maximization point. Where they’re equal, the slopes are equal.
When price goes up, the budget line rotates inward. Must find a new bundle on a lower indifference curve.