9

Consumer Behavior

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
 Law of Diminishing Marginal Utility

• Utility is the satisfaction one gets from

consuming a good or service
• Not the same as usefulness
• Subjective
• Difficult to quantify

LO1
 Law of Diminishing Marginal Utility

• Util is one unit of satisfaction or

pleasure
• Total utility is the total amount of
satisfaction
• Marginal utility is the extra satisfaction
from an additional unit of the good
MU = ΔTU/ΔQ
f-

change of total utility

change of total Quantity

LO1
 Law of Diminishing Marginal Utility

• As consumption of a good or service

increases, the marginal utility
obtained from each additional unit of
the good or service decreases
• Explains downward sloping demand

LO1
 Total Utility and Marginal Utility
Total Utility

T 30
(1) (2) (3) T
Tacos Total Margina o
Consume Utility, l U
d Utils Utility, t 20
Per Meal Utils a
0 0] 1 l
10
U
1 1
] 0 ti
2 0
] 8 li 0 1 2 3 4 5 6 7
3 1 t
] 6 M
y
4 8
] 4 a
(
rU 10
5 2
] 2 g
ti
8
6 4 6
] 0 il 4
7 2 n 2
-2 s
8 a
) 0
l -
3
U 2 1 2 3 4 5 6 7
0 ti MU
3 li
LO1
 0

Theory of Consumer Behavior

• Rational behavior
• Preferences
• Budget constraint
• Prices

LO2
 Utility Maximizing Rule

• Consumer allocates his or her income

so that the last dollar spent on each
product yields the same amount of
extra (marginal) utility
• Algebraically
MU of product A =MU of product B
Price of A Price of B
y

LO2
 Numerical Example
The Utility Maximizing Combination of Apples and Oranges Obtainable with an
Income of $10
I (2) (3)
Apple (Product A): Oranges (Product B):
Price = $1 Price =-$2 $1

(b) (b)
(a) Marginal Utility (a) Marginal Utility
(1) Marginal Utility, per dollar Marginal Utility, per dollar
Unit of Product Utils (MU/Price) Utils (MU/Price)
First 10 10 ✗ 24 12
Second 8 8 20 10
Third 7 7 18 9 ¥
Fourth 6 6 16 8
Fifth 5 5 12 6
Sixth 4 4 6 3
Seventh 3 3 4 2
LO2
 income spent income remaining

1st B 10 -
I 9
2nd At B g -

z 7
3rd B F -
I 6

4th At B
 Decision-Making Process
Sequence of Purchases to Achieve Consumer Equilibrium, Given the data in
Table 6.1

Marginal
Choice Utility Income
Number Potential Choices per Dollar Purchase Decision Remaining
1
G First Apple
First Orange
10
12
First orange for $2 $8 = $10 - $2

2 First Apple 10 First apple for $1 $5 = $8 -$3

Second Orange 10 and Second orange for $2

3 Second Apple 8 Third orange for $2 $3 = $5 - $2

Third Orange 9

4 Second Apple 8 Second apple for $1 $0 = $3 - $3

Fourth Orange 8 and Fourth orange for $2

LO2
 Deriving the Demand Curve

$2

Price Per Quantity P

Orange Demande ri
d c
$2 4
e
1 6 o
f $1
O
r
a D
n 0 O
g 4 6
e Quantity Demanded of Oranges

LO3
 Income and Substitution Effects

• Income effect
• The impact that a price change has
on a consumer’s real income
• Substitution effect
• The impact that a change in a
product’s price has on it’s relative
-

expensiveness

LO4
 Applications and Extensions

• New products
• iPod
• Diamond-water paradox
• Opportunity cost and time
• Medical care purchases
• Cash and noncash gifts

LO5
 Prospect Theory

• How people actually deal with life’s up

and downs
• People judge things relative to the
status quo
• People experience:
• Diminishing marginal utility for gains
• Diminishing marginal disutility for losses
• People are loss adverse
LO5
 Losses and Shrinking Packages

• Consumers see any price increase as

a loss relative to the status quo
• Producers are reducing package size
instead of raising prices

LO5
 Framing Effects and Advertising

• Consumers evaluate events in a

particular mental frame
• New information alters the frame in
which the consumer defines whether
situations are gains or losses

LO5
 Anchoring and Credit Card Bills

• Estimates of value are influenced by

recent information no matter how
irrelevant
• Can lead to people altering valuations
unconsciously

LO5
 Mental Accounting and Warranties

• Separate purchases into “mental

accounts” rather than looking at the
big picture
• Mental accounting exaggerates any
potential loss

LO5
 The Endowment Effect

• Market transactions may be affected

by the endowment effect because:
• The seller has a tendency to
demand a higher price
• The buyer has a tendency to offer a
lower price

LO5
 Nudging People

• Using behavioral economics to

change people’s behavior
• Subtle manipulations are used to
generate socially better outcomes
• Unaware of being manipulated

LO5