Consumer behavior

Discussion

Utility - Cardinal and Ordinal Total utility and marginal utility Indifference curve analysis Revealed preference theory - concept Using the characteristics for demand analysis-

concept

Behavioral perspectives on decision making

Utility – subjective, post consumption satisfaction, user specific, ethically neutral, changes with time, perception and income.

Cardinal utility (Jevons, Menger, Walras, Marshall)

Ordinal utility (Slutsky, Pareto, John Hicks)

Cardinal utility

Total utility

Marginal utility

Principle of diminishing marginal utility

As a person continues the consumption of a good with ceteris paribus condition, the total satisfaction derived will increase but at decreasing rate.

Neha’s utility from consuming crisps (daily)

Packets of crisps

consumedTU in utils MU in

utils

0 0 0

1 7 7

2 11 4

3 13 2

4 14 1

5 14 0

6 13 -1

The ceteris paribus assumptions

Are there any goods or services where consumers do not experience diminishing marginal utility?

Utility/welfare measurements

Consumer surplus - the excess of what a person would have been prepared to pay for a good (i.e. the utility) over what that person actually pays

Marginal consumer surplus - the excess of utility from the consumption of one more unit of a good (MU) over the price paid :

MCS = MU - P

Total consumer surplus - the excess of a person’s total utility from the consumption of a good (TU) over the amount that a person spends on it (TE):

TCS = TU - TE

Rational consumer behavior - people will go on purchasing additional units as long as they gain additional consumer surplus (MU>P)

Optimum level of consumption - MU = P

If a good were free, what would be the level of consumer surplus?

MU and demand curve

Water-Diamond Paradox

What determines the market value of a good?

 Karl Marx and David Ricardo- value depends on the amount of resources used

 Adam Smith (1760s) – ‘How is it that Water which is so essential to human life, and thus has such a high ‘value-in-use’, has such a low market value? And how is that diamonds which are relatively so trivial have such a high market value?’

MU revolution in 1870s - Jevons(UK) Carl Mager(Austria) and Walras(Switzerland) claimed that the source of market value is its MU, not its TU.

Diminishing marginal utility of income- moral argument for redistributing income

Drawbacks

Weaknesses of the one commodity version of marginal utility theory

Effects on substitutes and complimentary goods and leftover income

Constant marginal utility of money

The Equi-marginal Utility Principle- the optimum combination of goods consumed - consumer will get the highest utility from a given level of income when the utility from the last re.1 spent on each good is the same.

Suppose Px=2/- and Py=2/-, I=20/-, and he spends it all on X and Y.

1. State the equilibrium for this individual2. If “commodity” Y is savings, how would the

equilibrium condition be affected3. Suppose that MUx increased continuously as the

individual consumed more of X while MUy remains constant, how should the consumer rearrange his expenditure to maximize utility

ExerciseQ 1 2 3 4 5 6 7 8 9 10 11

Mux 15 14 11 10 9 8 7 6 5 3 1

Muy 15 13 12 8 6 5 4 3 2 1 0

Ordinal utility- Indifference curve analysis Consumer Preferences Budget Constraint

Basic Assumptions Completeness- preferences ignore costs Reflexivity- bundle is as good as others Transitivity- preferences are consistent and

rational More to Less

Indifference curve - a line showing all those combinations of two baskets of goods between which a consumer is indifferent

Characteristics of an ICslopes downward to righttwo ICs cannot intersect each other higher IC gives higher level of satisfactionconvex to origin

Marginal rate of substitution (MRS) between two goods in consumption

Diminishing MRS

Indifference map

Budget constraint

Which of the following diagrams correspond to which

of the following?

Y

O X

Y

O X

a) x and y are left shoes and right shoes.

b) x and y are two brands of the same product, and the consumer cannot tell them apart.

Optimization of satisfaction by consumer

MRSxy = Px/Py

Px/Py = MRSxy = Mux/Muy = X/ Y

Px/Py = Mux/Muy

Mux/Px = MUy/Py

The effect of changes in income

Real income

Income-consumption curve

The effect of change in price

Price-consumption curve

Price effect = Substitution effect + Income Effect

Income effect of a price change

Substitution effect of a price change

Compensating variation – excludes the change in real income

Giffen goods - accounting for large proportion of consumer expenditure which leads to significant effect on the real income resulting in abnormal income effect outweighing normal substitution effect

Application of indifference curve analysis

Choices by consumers

Buy one large pizza, get one large pizza free (limit one free pizza per customer)

Exercise

While at a discount shoe store, a customer asked a clerk, “I see that your shoes are ‘buy one, get one free- limit one free pair per customer: will you sell me one pair for half-price?” The clerk answered, “I can’t do that,” when the customer started to leave the store, the clerk hastily offered, “however, I am authorized to give you a 40% discount on any pair in the store.” Assuming the consumer has Rs.2000/- to spend on shoes (x) or all other goods (y), and that shoes cost Rs.1000/-per pair, answer the following questions:

A) Illustrate the consumer’s opportunity set under the ‘buy one, get one free deal’ and under a 40% discount

B) Why was the 40% discount offered only after the consumer rejected the ‘buy one, get one free’ deal and started to leave the store?

C) Why was the clerk willing to offer a ‘buy one, get one free’ deal but unwilling to sell a pair of shoes for half-price?

Choice by consumer cont.

Gifts – cash or in-kind

Choices by workers and managers

A simplified model of income-leisure choice

The decision of a manager

Valuing output and profit both

Valuing output only

Valuing profit only

Limitations of IC Analysis

Difficult to derive ICs

Consumers may not be rational

Difference between expected satisfaction and gained satisfaction

Not applicable in case of consumer durables

Revealed Preference Theory

Assumptions

•Taste does not change

•Consistency

•Transitivity

•Consumer induced to purchase any basket of goods if its price is made sufficiently attractive.

The demand for characteristics - Lancaster’s approach to demand

•Goods demanded for their characteristics

•A good may possess more than one characteristics

•Style, flexibility, after sales service etc.