Download - Consumers behavior Theory
Learning Outcome
To develop competence through Knowledge, Sensitivity, Skills and Values in Managerial Economics through Consumer’s Behavior Theory
Topic Outline:• Definition of Consumer Behavior Theory• Two Utility Approaches used in Consumer
Behavior Theory• Definition of Utility• Basic Assumption• The Utility Function• LAW OF Diminishing MARGINAL UTILITY• Budget Line and Indifference Curve Analysis• Utility Maximization• Marginal rate of substitution• Optimum Combination and the Marginal Rate of
Substitution• An Individual Consumer’s Demand Curve• Substitution and Income Effects• Why demand slopes downward• Market Demand Curves• Paradox of value/ Water-Diamond Theory
References• Carlos Manapat and Fernando Pedrosa. Economics, Taxation and Agrian
Reform (Revised Edition). C & E Publishing, Inc Quezon City Philippines.
• Dominick Salvatore PhD. Microeconomics: Theory and Applications 4th edition McGraw-Hill Companies, Inc. (2003), NY USA.
• Evan J. Douglas. Managerial Economics and strategy 4th edition. A. Simon
and Schuster Company, Prentice Hall Inc(1993). NJ USA • James McGuigan, R. Charles Mayer, Frederick deB Harris. Managerial
Economics: Applications, Strategy and tactics 9th edition, South-Western Thomson (2006), OH USA.
• Keeney, R.L. and H. Raiffa. Decisions with Multiple Objectives: Preference and Value Tradeoffs. Cambridge University Press (1993), Cambridge.
• • Mark Hirschey. Fundamentals of Managerial Economics 9th edition,
South-Western Cengage Learning (2013), OH, USA.
References• Michael R. Baye, Managerial Economics and Business Strategy, 3rd
edition. The McGraw-Hill Companies, Inc.(1999), NY USA.
• R. H. Frank, Microeconomics and Behaviour, 9th edition, McGraw-Hill Companiess, Inc. (2014), NY USA.
• S. Charles Maurice and Christopher R Thomas. Managerial Economics
9th edition McGraw-Hill (2008), NY USA. • Wayne D. Hoyer; Rik Pieters; Deborah J MacInnis Mason. Managerial
Economics 6th edition. South-Western Cengage Learning (2003). OH USA.
• http://www.referenceforbusiness.com/management/ Utility-Theory.html • http://www.mymba.com/management/ economics-definition.html
Managerial Economics• provides a useful framework for understanding how consumers make trade-off. Every consumer decision involves trade-offs between price, quantity, timeliness and host of related factors. The consideration of such trade-offs and the methods used by the consumers to make consumption decisions are called the study of consumer behavior (Hirschey).
Consumer Behavior Theory
Consumer Behavior
economics
marketing
social anthropology
sociology
psychology
Consumer Behavior Theory• The study of individuals, groups, or organizations and the processes they use to select, secure, use, and dispose of products, services, experiences, or ideas to satisfy needs and the impacts that these processes have on the consumer and society.
• The theory of consumer behavior provides the foundation for the study of consumer demand
• Follows directly from the theory of maximization
Consumer Behavior Theory
principles to describe consumer behavior
Incentives
Marginal Changes
Opportunity Cost
Trade-off
Consumer Behavior Theory• Utility – the satisfaction of individual receives from goods or combination of goods.
• Utility approach provides a methodological framework for the evaluation of alternative choices made by individuals, firms and organizations
Consumer Behavior Theory - Utility Approach
Basic Assumption
Consumers are rational
Preferences are transitive
Preferences are complete
Nonsatiation Principle
Consumer Behavior Theory - Utility Function
• utility function is an equation that shows an individual’s perception of the level of utility that would be attained from consuming each conceivable bundle (or combination) of goods.
U = index of utility depending on the
quantities consumed of goods or servicesX, Y = amount goods or services consumedf = function of
Consumer Behavior Theory
Two Utility Approaches
Budget Line and Indifference Curve Analysis
LAW OF Diminishing MARGINAL UTILITY
LAW OF Diminishing MARGINAL UTILITY is the law of economics stating that as a person increases consumption of a product - while keeping consumption of other products constant - there is a decline in the marginal utility that person derives from consuming each additional unit of that product.
budget line is the locus of all combinations or bundles of goods that can be purchased at given prices if the entire money income is spent.
indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility
LAW OF Diminishing MARGINAL UTILITY
LAW OF Diminishing MARGINAL UTILITY
Marginal utility
Total utility
1. The number of units of utility that a consumer gains from consuming a given quantity of a good, service, or activity during a particular time period.
2. The higher a consumer’s total utility, the greater that consumer’s level of satisfaction.
The amount by which total utility rises with consumption of an additional unit of a good, service, or activity, all other things unchanged
MU U X
As a consumer has more of a ‘good’, the extra (marginal) utility they enjoy from each successive extra unit of the good declines
The Budget Line• Opportunity Set
The set of consumption bundles that are affordable.
•PxX + PyY M.• Budget Line
Shows all possible commodity bundles that can be purchased at given prices with a fixed money income
•PxX + PyY = M• Market Rate of Substitution– The slope of the budget line•-Px / Py
Y
X
The Opportunity Set
Px
Py
Budget Line
X YM P X P Y
X
Y Y
PMY XP P
o rX YM P X P Y
X
Y Y
PMY XP P
o r
Changes in the Budget Line
• Changes in Income– Increases lead to a parallel, outward shift in the budget line.
– Decreases lead to a parallel, downward shift.
• Changes in Price– A decreases in the price of good X rotates the budget line counter-clockwise.
– An increases rotates the budget line clockwise.
X
Y
X
YNew Budget Line for a price decrease.
Shifting Budget Lines: Change in Money
(increase)Original Given Budget line ABPx = P 5.00Py = P 10.00M = P1,000.00
Formula:PxX + PyY = M
New Given:M = P2,000.00Slope of the line = 1/2
Formula: M / PxX M /
PyY
Budget line RN
Shifting Budget Lines: Change in Money
(decrease)Original Given Budget line ABPx = P 5.00Py = P 10.00M = P1,000.00
Formula:PxX + PyY = M
New Given:M = P 800.00Slope of the line = 1/2
Formula: M / PxX M /
PyY
Budget line FZ
Panel B – Changes in price of X
200
100A
B250
D
R
N
120
240
Shifting Budget Lines : Graph
Quan
tity o
f Y
Quantity of X
Panel A – Changes in money income
Quan
tity
of Y
Quantity of X
A
B
100F
Z
80
160 200 125C
Shifting Budget Lines: Change in Price
(decrease)Original Given Budget line ABPx = P 5.00Py = P 10.00M = P1,000.00
Formula:PxX + PyY = M
New Given:
Px = P 4.00Vertical intercept = same (M / PyY = 100 units)
Budget line ADM / PXX= 250 units
Shifting Budget Lines: Change in Price
(increase)Original Given Budget line ABPx = P 5.00Py = P 10.00M = P1,000.00
Formula:PxX + PyY = M
New Given:
Px = P 8.00Vertical intercept = same (M / PyY = 100 units)
Budget line ACM / PXX= 125 units
Panel B – Changes in price of X
200
100A
B250
D
R
N
120
240
Shifting Budget Lines Graph
Quan
tity o
f Y
Quantity of X
Panel A – Changes in money income
Quan
tity
of Y
Quantity of X
A
B
100F
Z
80
160 200 125C
Indifference Curve Analysis
Indifference Curve– A curve that defines the combinations of 2 or more goods that give a consumer the same level of satisfaction.
Marginal Rate of Substitution– The rate at which a consumer is willing to substitute one good for another and stay at the same satisfaction level.
I.
II.
III.
Good Y
Good X
Indifference curve
The properties of
indifference curve
cannot intersect
downward-sloping / negatively sloped
convex
Locus of points representing different bundles of goods, each of which yields the same level of total utility
Indifference Curve All combination in the indifference curve yield the consumer the same level of utility
Indifference Curve Indifference Curve I Indifference Curve II
Product X Product Y Product X Product Y 1 12 2 122 10 3 83 8 4 44 7 5 25 66 5
Indifference curve : illustration Indifference Curve I
Indifference Curve II
Indifference Curve III
Qx1 Qy1 Qx2 Qy2 Qx3 Qy31 10 3 10 5 122 5 4 7 6 93 3 5 5 7 74 2.3 6 4.2 8 6.25 1.7 7 3.5 9 5.56 1.2 8 3.2 10 5.27 0.8 9 3 11 58 0.5 10 2.9 12 4.99 0.3 10 0.2
Utility maximization
Utility maximization (constraint/
tools to analyze)
Marginal rate of substitution
expanded maximization principle
Marginal utility interpretation of
equilibrium
Maximizing utility subject to a limited money income
Maximizing utility subject to a limited money incomeUtility maximization subject to a limited money income occurs at the combination of goods for which the indifference curve is just tangent to the budget line
X X
Y Y
MU PYMRSX MU P
Consumer allocates income so that the marginal utility per dollar spent on each good is the same for all commodities purchased
X Y
X Y
MU MUP P
A•
I
C•
•B
II
R
T
Utility Maximization:
Quantity of burgers
Quanti
ty of
pizzas
0 8020 10040 60
10
20
30
40
50
7010 9030 50
•EIII
•D
IV
45
15
Given :
Budget = P 400.00
Ppizza = P 8.00Pburger = P 4.00
Marginal utility interpretation of
equilibrium• The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction.
I.
II.
III.
X
Y
Consumer Equilibrium
Marginal utility interpretation of equilibrium : illustrationGiven
Px = P 4.00Py = P 2.00Qx = 20 unitsQy = 30 units M = P 140.00
Suppose that the MU of last unit of X is 20 and the MU of Y is 16.
5<8
Expanded maximization principle
• We have assumed that the consumer purchases only two goods. The analysis is easily extended to any number of goods.
Marginal rate of substitution
• The marginal rate of substitution (MRS) is a measure of the number of units of Y that must be given up per unit of X added so as to maintain a constant level of utility.
Optimum Combination
• The combination of the budget line and indifference curve as shown in the graph will shows the optimum combination or optimal combination
Budget Schedule Indifference SchedulePoint
sProduct
XProduct
YPoint
sProduct
X Product YA 8 0 J 2 8B 7 1 K 3 6C 6 2 L 4 4D 5 3 M 6 3E 4 4 N 7 2F 3 5 G 2 6 H 1 7
Optimum Combination : illustration
Using the principle of marginal rate of substitution, we can see that at point L on the indifference curve, the ratio of product Y to product X is 4:4 or 1:1.
Given:Budget = P 8.00Px = P 1.00Py = P 1.00
Individual Demand Curve
• An individual’s demand curve is derived from each new equilibrium point found on the indifference curve as the price of good X is varied.
X
Y
P
X
D
III
P0
P1
X0 X1
Deriving a Demand Curve : illustration
M = P 1,000.00PX = P 10.00 Py = P 10.00Budget line 1 = 100Y to 100XDemand schedule for product X
Price Quantity Demanded
P 10.00
50
8.00
65
5.00
90
Deriving a Demand Curve : illustration
Quanti
ty of
YPr
ice of
X
(P)
Quantity of X
Quantity of X
100
2001251000
0
Px=P10
Px=P5
Px=P8
906550
906550
5
810
Demand for X
Market Demand & Marginal Benefit
• List of prices & quantities consumers are willing & able to purchase at each price, all else constant
• Derived by horizontally summing demand curves for all individuals in market
• Because prices along market demand measure the economic value of each unit of the good, it can be interpreted as the marginal benefit curve for a good
Derivation of Market Demand
Quantity demanded
Price Consumer 1 Consumer 2 Consumer 3 Market demandP6
21
543
3
1213
5810
0
710
135
0
68
014
3
2531
61219
Substitution and Income Effects
When price changes, total change in quantity demanded is composed of two parts
Income Effects
Substitution EffectsThe substitution effect is the change in the consumption of a good that would result if the consumer remained on the original indifference curve after the price of the good changes.
The income effect from a price change is the change in the consumption of a good resulting strictly from the change in purchasing power. The direction of the income effect is uncertain.
Substitution EffectsGiven:Budget line (M) = P 150.00PX = P 15.00 Py = P 7.5
Original Budget line : AB
Given new:Budget line (M) = P 150.00PX = P 6.00 Py = P 7.5
New Budget line : AD
Income & Substitution Effects: A Decrease in
PxTotal effect of price decrease
= Substitution effect
+ Income effect
9
= 5 + 4
Total effect of price decrease
= Substitution effect
+ Income effect
3
= 5 + (-2)
Substitution & Income Effects
• Consider the substitution effect alone:– Amount of good consumed must vary inversely with price
• Income effect reinforces the substitution effect for a normal good & offsets it for an inferior good
Summary of Substitution & Income Effects
Substitution Effect
Income Effect
Price of X decreases:Normal Good
Inferior GoodPrice of X increases:
Normal GoodInferior Good
X risesX rises
X rises
X rises
X falls
X fallsX falls
X falls
Paradox of value/ Water-Diamond Theory
states that a good with more value in use has less or little value in exchange and a good with more value in exchange has less or little in value in use.