Applied Economics

Lecture 7
Consumer behaviour

Chapter 7
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Syllabus
1. Introduction / Economic principles
2. Supply and demand
3. Elasticities
4. Firm behaviour
5. Production, pricing and market structures (I)
6. Production, pricing and market structures (II)
7. … Reading Week…
8. Consumer Theory
9. Behavioural Economics & Policy
10.Macro Aggregates - Aggregate demand/supply
11.Unemployment & Inflation
12.Fiscal, monetary and supply-side policies
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The Standard Economic Model
§ Based on four main assumptions
§ Buyers are rational
§ More is preferred to less
§ Buyers seek to maximise utility
§ Buyers act in self-interest

§ Definitions
§ Value: the worth to an individual of owning an
item represented by utility
§ Utility: the satisfaction derived from
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consumption
‘Utility’
§ Total utility rises at first as additional units
are consumed
§ reaches a maximum and then begins to fall

§ Marginal utility – the addition to

satisfaction from the consumption of
successive units
§ Diminishing marginal utility – the ‘law’
that states that marginal utility falls as
consumption increases
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The Consumer’s Budget Constraint

The consumer’s budget constraint: the various bundles of goods the

consumer can afford with a given income

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The Consumer’s Preferences

The consumer’s optimum: the point where the marginal utility spent on one good
equals the marginal utility per euro spent on another good.

There is no incentive for the consumer to change their spending behaviour at

this point and increase utility given their budget constraint.
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The Consumer’s Optimum

MUX / PX = MUY / PY

The consumer’s optimum: the point where the marginal utility spent on one good
equals the marginal utility per euro spent on another good.

There is no incentive for the consumer to change their spending behaviour at

this point and increase utility given their budget constraint.
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An Increase in Income

An increase in income shifts the budget constraint outwards allowing greater

consumption of both goods on a higher indifference curve

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An Inferior Good

An Inferior Good: when the budget constraint shifts outwards the consumer
buys less of the good

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A Change in Price

If the price of a good changes the budget line will pivot.

In this case a fall in the price of cola means the budget constraint pivots
outwards and the consumer can afford to buy more cola.

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 Behavioural Theories
§ Note that consumers do not always behave
according to the assumptions of the standard
model (discussed in slide 3)
§ Specifically:
§ People tend to be overconfident
§ Give too much weight to a small number of
observations
§ Are reluctant to change their minds
§ Have a tendency to look for examples which
confirm their existing view
§ People use rules of thumb to make 12decisions
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Type of Heuristics
§ Anchoring – using familiarity to make decisions
§ Availability – assessing risks of the likelihood of
something happening
§ Representativeness – decisions made based on
how representative something is to a stereotype
§ Persuasion – attributes a consumer attaches to a
product or brand
§ Simulation – visualising or simulating the
outcome of a decision

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Implications: the case of Advertising &
Branding
§ Critique:
§ Advertising often is psychological rather than
informative
§ Creates a desire that might not exist
§ Impedes competition

§ Defence:
§ Does provide information: price, availability,
quality
§ More information means greater competition
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§ Acts as a signal of quality