Consumer Behaviour

“Consumer
Behavior”
1
©2004 Prentice Hall Publishing Ayers/Collinge, 1/e
6.1
6.1
THE
THE LAW
LAW OF
OF DEMAND
DEMAND REVISITED
REVISITED
•• Demand
Demand slopesslopes downward
downward according
according to to the
the law
law of
of
demand.
demand.
•• The
The law
law isis demand
demand isis caused
caused in in part
part by by the
the
substitution
substitution effect.
effect.
•• The
The substitution
substitution effect
effect of
of aa price
price change,
change, which
which
occurs
occurs when
when aa lower
lowerprice
price onon aa good
good causes
causes aa person
person
to
to buy
buy more
more ofof that
that good
good instead
instead of of alternative
alternative
goods.
goods.
•• Likewise,
Likewise, the the substitution
substitution effect
effect of
of increasing
increasing thethe
price
price of
of aa good
good would
would drive
drive consumers
consumers to to buy
buy more
more
of
of the
the substitute
substitute good
good instead
instead ofof the
the good
good with
with the
the
increased
increased price.
price.
2
The
The Law
Law of
of Demand
Demand Revisited
Revisited
oo For
For aa normal
normal good,
good, the
the income
income effect
effect of
of aa
price change
price change will
will also
also cause
cause demand
demand toto
slope down.
slope down.
The income
oo The income effect
effect occurs
occurs when
when thethe price
price
change affects
change affects consumer
consumer purchasing
purchasing
power, termed
power, termed real
real income,
income, andand thus
thus
leads to
leads to aa change
change inin quantity
quantity demanded.
demanded.
oo AAhigher
higher price
price reduces
reduces real
real income,
income, while
while
aa lower
lower price
price increases
increases real
real income.
income.
3
6.2
6.2
UTILITY
UTILITYAND
AND CONSUMER
CONSUMER
SATISFACTION
SATISFACTION
Consumers
 Consumers buy buy inin order
order toto obtain
obtain utility,
utility,
which isis the
which the satisfaction
satisfaction received
received from
from
the consumption
the consumption of of aa good.
good.
The
 The utility
utility that
that people
people gaingain from
from their
their
purchases isis subjective,
purchases subjective, varying
varying from
from
person to
person to person.
person.
Utility
 Utility does
does not
not imply
imply that
that aa good
good isis
useful.
useful.
4
Two
Two Approaches
Approaches to
to Measure
Measure the
the
Utility
Utility
GOOD Utility in Rank Order

Utils
X1 14 2nd
X2 03 5th
X3 10 3rd
X4 08 4th
X5 17 1st
5
Total
Total and
and Marginal
Marginal Utility
Utility

Although
Although utility
utility isis not
not measurable,
measurable, itit cancan bebe
modeled
modeled as as though
though itit were,
were, using
using the
the util
util as
as its
its
unit
unit of
of measure.
measure.

Total
Total utility
utility equals
equals thethe sum
sumof of the
theutils
utils aaperson
person
receives
receives from
from consuming
consuming aa specific
specific quantity
quantity of of
aa good.
good.

Marginal
Marginal utility
utility equals
equals the the increments
increments to to total
total
utility
utility from
from changes
changes in in consumption.
consumption.
6
Total
Total and
and Marginal
Marginal Utility
Utility
Utils
150
Marginal
utility
100
Total
Utility
50
0
First Slice Second Slice Pizza
7
Total
Total and
and Marginal
Marginal Utility
Utility
Marginal Utility = Change in total utility

Change in number of
units consumed
8
Diminishing
Diminishing Marginal
Marginal Utility
Utility
The
The law
law of
of diminishing
diminishing marginal
marginal utility
utility
decrees
decrees that
that the
the first
first unit
unit of
of aa good
good isis
most
most satisfying,
satisfying, after
after which
which additional
additional
units
units provide
provide progressively
progressively lessless and
and less
less
additional
additional utility.
utility.
There
There isis aa satiation
satiation point,
point, beyond
beyond which
which
additional
additional consumption
consumption actually
actually reduces
reduces
utility.
utility.
9
Diminishing
Diminishing Marginal
Marginal Utility
Utility
The
The law
law of
of diminishing
marginal utility
utility
decrees
decrees that
that the
the first
first unit
unit of
of aa good
good isis
most
most satisfying,
satisfying, after
after which
which additional
additional
units
units provide
provide progressively
progressively lessless and
and less
less
additional
additional utility.
utility.
There
There isis aa satiation
satiation point,
point, beyond
beyond which
which
additional
additional consumption
consumption actually
actually reduces
reduces
utility.
utility.
10
Total
Total and
and Marginal
Marginal Utility
Utility
11
Total
Total and
and Marginal
Marginal Utility
Utility
Utility
Total Utility is
Satiation point
maximized when
Utility marginal utility is
zero.
Satiation point
12
Utility
Utility MAXIMIZATION
MAXIMIZATION
• A consumer will maximize his utility when
the marginal utility from that good is just
equal to the price of the good , other thing
being the same .
• MUx = Px
13
14
Assume
Assume thatthat the
the utility
utility can
can be
be measured
measured in in Rs.
Rs. From
From
the
the utility
utility schedule
schedule given
given below
below .find
.find how
how many
many
Cokes
Cokes the
the consumer
consumer would
would consume
consume at at the
the price
price of
of
Rs.
Rs. 99 per
per Coke
Coke..
Cokes Total utility

1 30
2 45
3 54
4 59
5 59
15
• . Ms. Swati is a managerial economist by profession and an ardent
believer in the validity of economic laws. After a long wait she
could finally get time to go for a movie – a pastime she cherishes.
In the 15-minute interval time she walked out of the hall and sat
down on the sofa placed in restaurant in the theatre lobby. She
happened to glance at the price list displayed at the side of the
restaurant and found that a cup of coffee was available for Rs. 10.
Being an economist in every thought and action she immediately
calculated that to her satisfaction expected from the cup of coffee
was not higher than the satisfaction she could derive from
spending Rs. 10 on some alternative purchase. She decided not to
buy the cup of coffee as she placed the same value to the cup of
coffee as she did to a ten-rupee note.
• Then to her surprise, she noticed that the cup of coffee was also
accompanied by a pair of biscuits (at no extra cost). She ordered a
cup of coffee.
• Can you give a rational behind the evaluation of the choice made
by Ms. Swati? (10)
16
6.3
6.3
MAXIMIZING
MAXIMIZING UTILITY
UTILITYSUBJECT
SUBJECTTO
TOAA
BUDGET
BUDGET CONSTRAINT
CONSTRAINT
The
 The budget
budget constraint,
constraint, aa consumer’s
consumer’s income,
income, curbs
curbs
the amount
the amount of of total
total utility
utility that
that can
can be
be obtained.
obtained.
Consumers
 Consumers must must choose,
choose, while
while striving
striving to to spend
spend
theirincomes
their incomes so so as
as to
to obtain
obtain thethe greatest
greatest
satisfaction from
satisfaction from their
theirincomes.
incomes.
Consumers
 Consumers maximize
maximize utility
utility subject
subject toto their
their
budget constraint.
budget constraint.
Utility
 Utility maximization
maximization isis achieved
achieved when
when the the
consumer’s choices
consumer’s choices provide
provide thethe greatest
greatest amount
amount ofof
total utility
total utility for
foraa specific
specific amount
amount of of time.
time.
17
Spending
Spending at
at the
the Margin
Margin
•• When
When marginal
marginal utility
utility isis divided
divided by by the
the prices
prices of
of
goods
goods and
and services,
services, the
the result
result isis called
calledmarginal
marginal
utility
utility per
perdollar
dollarororRUPEE.
RUPEE.
•• The
The rule
rule of
of utility
utility maximization
maximization is… is…
–– To
Tomaximize
maximizeutility,
utility,aaconsumer
consumeradjust
adjustspending
spendinguntil
until
the
themarginal
marginalutility
utilityfrom
fromthe
thelast
lastdollar
dollaror orRupee
Rupee
spent
spenton
oneach
eachgood
goodisisthe
thesame.
same.ItItisiscalled
calledthe
thelaw
lawof
of
Equi-
Equi-marginal
marginalUtility.
Utility.
18
Algebraic
Algebraic Statement
Statement ofof the
the Utility
Utility
Maximizing
Maximizing Rule
Rule ,Two
,Two or
or more
more
goods
goods
Marginal Utility of Y
Marginal Utility of X
= Price of Y,
Price of X
If the marginal utility per dollar of product X is greater

than the marginal utility per dollar of product, consumers
should purchase more of product X.
Conversely, if the marginal per dollar of product Y is greater
than the marginal utility of product Y, consumers should
purchase more of product Y.
19
Consumers
Consumers Equilibrium
Equilibrium
• MUx/Px=MUy/Py
• or
• MUx/MUy=Px/Py
20
Utility
Utility Maximizing
Maximizing
DENISE’S PREFERENCES FOR MOVIES AND BOTTLED WATER
[Price of movie ticket = $3; Price of water = $1 per bottle; Income = $15 per week]
1 2 3 4 5 6
Number of Marginal Utility Marginal Utility
Movie Marginal Utility per dollar for Number of Marginal Utility of per dollar for
Tickets of Movies movies (Marginal Bottles of Bottled Water bottled water
Bought (in utils) Uitlity/Price) Water Bought (in utils) (Marginal
1 30 10 1 8 8
2 27 9 2 7 7
3 24 8 3 6 6
4 18 6 4 5 5
5 8 2.67 5 4 4
6 1 0.33 6 3 3
21
Utility
Utility Maximization
Maximization and
and Demand
Demand
When consumers
When consumers maximize
maximize utility
utility their
their
individual demand
individual demand curves
curves for
foraa good
good are
are
downward sloping.
downward sloping.
In other
In otherwords,
words, the
the quantity
quantity demanded
demanded of of aa
good will
good will change
change in in the
theopposite
opposite direction
direction to to aa
change in
change in its
its price.
price.
The law
The law of
of diminishing
marginal utility
utility isis
anotherexplanation
another explanation for forthe
the downward
downward sloping sloping
demand curve.
demand curve.
22
Utility
Maximization and
and Demand
Demand
A LOWER PRICE FOR MOVIE TICKETS INCREASES
MARGINAL UTILITY PER DOLLAR
Number of Marginal Utility Marginal Utility per
Movie Marginal Utility per dollar , Price = dollar, Price = $2
Tickets of Movies $3 (Marginal (Marginal
Bought (in utils) Uitlity/Price) Uitlity/Price)
1 30 10 15
2 27 9 13.5
3 24 8 12
4 18 6 9
5 8 2.67 4
6 1 0.33 0.5
23
Utility
Maximization and
and Demand
Demand
$
Utility maximization
causes demand to
slope downward.
$3
$2
Denise’s
demand
4 5 Quantity of movies
24
An
An Alternative
Alternative Approach
Approach to
to
Derive
Derive Demand
Demand Curve
Curve
• This approach is also known as the
“indifference curve approach”.
• Substitution Effect
• Income Effect: HERE IT REFERS TO
REAL INCOME.
25
Derivation
Derivation of
of Market
Market Demand
Demand
Price Ahmed Bobby Chetan Total Point ON
per market
Shirt Demand
curve
300 0 0 0 0 A
275 1 0 0 1 B
250 2 1 0 3 C
200 3 2 1 6 D
175 4 3 2 9 E
26
Types
Types of
of Demand
Demand
Study Yourself
27
The
The Paradox
Paradox of
of Value
Value
• It is seen that items of great value e.g. water
,air etc. are often sold at negligible prices
while jewelry with very little use to
mankind are sold at exorbitant prices.the
paradox of value deals basically with the
reason why consumers pay zero or very less
amount of money for certain with very high
benefits.
28
• Adam Smith ,in his book THE WEALTH OF
NATIONS discussed ‘the diamond water paradox’
.How is it so that the demand for water being so
high its price is very low and the demand of
diamond in spite of being very low faces such
high prices .
• The relative abundance of water in most places
brings its marginal utility very close to zero.On
the contrary due to scarcity diamonds all over the
world its marginal utility is always maintained at a
very high level.
29
A
A Consumer
Consumer has has an
an income
income of of
Rs.
Rs. 19
19 for
for aa week
week and
and wants
wants toto
spend
spend his
his all
all income
income on on three
three
goods
goods X,Y,Z
X,Y,Z Prices
Prices are
are Rs.5,3,1
Rs.5,3,1
per
per unit
unit .Determine
.Determine howhow the
the
consumer
consumer will
will allocate
allocate his
his
income
income onon the
the three
three goods.
goods.
30
Units Marginal utilities
X Y Z
1 30 18 8
2 25 15 7
3 20 9 5
4 15 6 4
5 5 4 3
31
A
A family
family has
has aa monthly
monthly budget
budget
of
of Rs.340
Rs.340 forfor Cheese,
Cheese, Fish
Fish and
and
Meat.
Meat. Prevailing
Prevailing prices
prices are
are
Rs.20,40,50
Rs.20,40,50 respectively.The
respectively.The
total
total utility
utility schedule
schedule isis given
given
below:What
below:What is is the
the maximum
maximum
total
total utility
utility that
that can
can be
be achieved
achieved
by
by the
the consumers?
consumers? 32
Consumpti Cheese Fish Meat
on
1 70 80 160
2 130 160 290
3 170 210 410
4 205 250 510
5 230 285 590
6 250 315 650
7
©2004 Prentice Hall Publishing
260 335 680
Ayers/Collinge, 1/e
33
Terms
Terms Along
Along the
the Way
Way

substitution
substitution effect
effect law
 law of
of diminishing
diminishing

income
income effect
effect marginal utility
marginal utility

utility
utility satiation
 satiation point
point

util
util marginal
 marginal utility
utility
 per dollar
per dollar
total
total utility
utility

marginal
marginal utility
utility

disutility
disutility
34
Test
Test Yourself
Yourself
1. When the price of a normal good decreases
a. the income and substitute effects both prompt the
consumer to purchase more of the good.
b. the income and substitute effects both prompt the
consumer to purchase less of the good.
c. the income effect prompts the consumer to
purchase less of the good, but the substitution
effect prompts the consumer to purchase more.
d. the income effect prompts the consumer to
purchase more of the good, but the substitution
effect prompts the consumer to purchase less.
35
Test
Test Yourself
Yourself
2.
2. Which
Which of of the
the following
following best
best describes
describes the
the
concept
concept of of utility?
utility?
a.
a. Utility
Utility isis measurable.
measurable.
b.
b. TheThe utility
utility of
of aa good
good must
must rise
rise the
the more
more useful
useful
itit is.
is.
c.c. Utility
Utility isis subjective.
subjective.
d.
d. TheThe utility
utility provided
provided by by any
any particular
particulargood
good
will
will be be the
the same
same forformost
most consumers.
consumers.
36
Test
Test Yourself
Yourself
3. The util is
a. unrelated to the concept of utility.
b. measurable with highly sensitive
electronic equipment.
c. used by economist to to illustrate
diminishing marginal utility .
d. a special kind of money used in
economic experiments.
37
Test
Test Yourself
Yourself
4. Marginal
4. Marginal utility
utility will
will be
be negative
negative when
when
the total
the total utility
utility curve
curve isis
a. rising.
a. rising.
b. falling.
b. falling.
c. at
c. at its
its maximum.
maximum.
d. in
d. in the
the negative
negative range.
range.
38
Test
Test Yourself
Yourself
5.
5. Consumer
Consumerequilibrium
equilibrium requires
requires the
the consumer
consumer
to
to
a.
a. maximize
maximize total
total utility.
utility.
b.
b. maximize
maximize marginal
marginal utility.
utility.
c.c. purchase
purchase amounts
amounts of of each
each good
good so
so that
that their
their
marginal
marginal utilities
utilities are
are equal.
equal.
d.
d. ignore
ignore the
the price
price of
of aa good
good inin deciding
deciding how
how
much
much to to consume
consume and and consider
consideronly
only the
theutility
utility
of
of aa purchase.
purchase.
39
Test
Test Yourself
Yourself
6.
6. The
The marginal
marginal utility
utility per
per dollar
dollar of
of aa
good
good equals
equals the
the goods
goods marginal
marginal utility
utility
a.
a. multiplied
multiplied by
by $1.
$1.
b.
b. divided
divided by
by $1.
$1.
c.
c. divided
divided by
by the
the price
price of
of the
the good.
good.
d.
d. multiplied
multiplied by
by the
the price
price ofof the
the good.
good.
40

Consumer Behaviour

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Consumer Behaviour

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“Consumer

GOOD Utility in Rank Order

Marginal Utility = Change in total utility

Cokes Total utility

If the marginal utility per dollar of product X is greater

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