Consumer Behavior

Prof.Paramita Malakar

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Date:25.01.2010. Place: MG Road

Yes, I am planning to go during March. But I do not know, how can I get You can go to any reputed tour information about tour package. Do company. I heard, Thomas cook is you know anybody, who can help me Thankgood. Hi Akash, How are Why dont you talk to them? I out? think they can solve your problem. you? you very much Hello Neel. Good to see you after a long time. So what is going on? I heard that you are planning for long Holiday, is it so?

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Date:10.02.2010 . Place: Infosys office

So, Neel where As per do you prefer toI know, your 1st preference is West go for Holiday? Europe. why have you chosen Thailand? I preferThere different to go is difference between places choice and preference. Let like Western Europe, Thailand, me explain. Malaysia. But my choice is Thailand.

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Preferences vs. choices

Choices

Preferences

Income/ Budget

Social Factors

Personal Factors

Make preference : express our like or dislike Choice/Choose: select from the preferred alternatives that suit our budget

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Date:25.03.2010 Place: Thailand

No, you have to tell me, which one will give you you feel like to take. I Whatever and have Raj, would you like maximum utility dontat anyany Problem. to have point French Fries orOk. Let for time it will not lead burger of to a lunch? And tell me take negative marginal me how an many do you want. utility example I will take 2 Burgers and I dont like to waste food. How would utility and marginal utility be correlated with my lunch?

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Utility
Utility: Satisfaction obtained from the consumption of the good and services preferred by consumer Anything that makes the consumer better off is assumed to raise his utility Anything that makes the consumer worse off will decrease his utility 1. Cardinal Approach: Utility can be measured in subjective unit 2.Ordinal Approach: Utility cant be measured but only rank Total Utility: Total satisfaction enjoyed from the consumption of good. More consumption lead greater utility Marginal Utility: Extra satisfaction a consumer can derive by consuming an extra unit of a good
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The law of diminishing marginal utility, as defined by Alfred Marshall (1842-1924) states that Marginal utility of a good or service to anyone diminishes with every increase in the amount of it he / she already has

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Cardinal Approach

Example: Total And Marginal Utility -- Burger Consumption

Number of cones 0 1 2 3 4 5 6
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Total Utility 0 50 88 121 146 146 126

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Marginal Utility 50 38 33 25 0 -20

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Total And Marginal Utility

Utils 146 121 90 50 25 5 1 2 3 4

Total Utility 1.The change in total utility from one more Burger . . .

6 Burger per day 3.Marginal utility falls as more Burger are consumed. Marginal Utility

Utils

50 38 33

2.is called the marginal utility of an additional Burger 1 2 3 4 5

6 Burger per day

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Date:27.03.2010 Place: Thailand

Neel, can How will you decide the we combine Burger and French Why not? But, we have to particular basket of Where the marginal utility per Burger and French Fries in our meal? decide the number of Burger Fries dollar of Burger is equal to Fries in every meal. and French (equilibrium point )? the marginal utility per dollar of FF

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Equal Marginal Utilities per rupee for every good

Consumer will try different combination of Burger and FF till the time, get marginal utility per dollar of Burger equal to marginal utility per dollar of FF

Burger per unit $6

Units Marginal MUc/P1 Utility

French Fries (FF) per unit $3

Units Marginal Utility MUb/P2

1 2 3 4 5
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50 38 33 25 0 -20

8.33 6.33 5.5 4.16 0

10 8 6 4 2

15 17 19 28 42 0

5.0 5.67 6.33 9.33 14 0

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-3.33Paramita/2010 0

Equal Marginal Utilities per dollar for every goodThe Equilibrium condition
MUc/P1=MUb/P2=Mum
Marginal Utilities

Mum P

MU1
Quantity of Burger

MUc= Marginal Utility of Burger MUb= Marginal Utility of French-fries MUm = Marginal Utility of money P1= Price of Burger P2=Price of French-fries
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Date:27.03.2010 Place: Thailand

It is very subjective. I.e. ordinal approach is most Neel, how do popular approach to deal you measure with utility.Like Rupee, generally we use But how does utils assign utils (unit) to measure the utility the utility? for commodity consumption?

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Assumptions on Preferences
Rationality: Preferences are logically consistent or transitive among different alternatives. Completeness: Consumer would prefer a to b or indifferent between d & e Transitivity: Consumer would prefer c to a and a to b. Consumer would prefer c to b More is better than less : Generally feel that more is better

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Ordinal Approach: consumer preferences

Quantity of French Fries

Preferred region d a b
Dominated region

a is preferred to all points in the dominated region but the consumer would prefer any point in the preferred region to a points like d and e involve more of one good and less of the other compared with a.

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Quantity of Burger

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Marginal Rate Of Substitution

An indifference curve like U2U2 shows all the consumption bundles that yield the same utility to the consumer ICs slope downwards. Consumer is willing to substitute one good for another( Marginal Rate Of Substitution) AB x MU FF+CD x MUB=U=0 AB/CD=MUB/MUFF=x1/x2=MRS their slope gets steadily flatter to the right U2 Convex to the origin : slope decreases as Burger consumption increases
D Quantity of Burger
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Quantity of FFs

U2 A

C
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Indifference Curve cant Intersect

Quantity of FFs U1 U2

a c b U1 U2

Violate assumption of consumer theory consumer would be indifferent among a, b and c But consumer would prefer c to b Quantity of Burger and French Fries more Give more utility

Quantity of Burger
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Shape Of Indifference Curve

Sit cover

cokes

IC1

IC0

IC

Pepsi
Perfect Substitute U( 04/14/12 x1,x2)= ax1+bx2 Slope=-a/b= Constant
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Car
Perfect Complements Always consume together in fixed proportion U( x ,x )=min{ ax bx }
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Shape Of Indifference Curve

Neutral good Bad good

IC

IC1 IC0

Normal good
Bad good x1 x2 =0 04/14/12 = m/P1; Slope=Upward Sloping
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Normal good
Neutral Good Slope= Vertical
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The Budget Constraint

FFs

m / P1

Slope = - P1/P2

Constraint Have to pay prices for the goods and services they buy Have limited funds to spend Budget constraint: combinations of goods and services the consumer can afford with a limited budget Mathematical expression: P1 * X 1+ P2 * X2 = m Where m is total income, P1 and P2 are prices for good X1 and good X2 respectively

Burger
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m / P2

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The Budget Constraint

Graphical representation of Budget line The price of one good relative to the price of another P1 * X 1+ P2 * X2 = m X2 =m/ P2 - P1 / P2 Interpretation on the vertical(m/P2) / horizontal intercepts(m/P1) The slope: the spending trade-off between one good and another Amount of one good, that must be sacrificed in order to buy more of another good
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Marginal Utility Approach

Consumers utility-maximizing choice

What is the best affordable combination of the two goods? Considering both marginal utility values and the budget constraint Highest possible utility will be point at which marginal utility per dollar is the same for both goods Otherwise, individual has incentive to deviate, i.e., chooses alternative combination
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The consumers choice

The point at which utility is maximized is found by bringing together the ICs and the budget line

The choice point is at C

FFs

U1

U2 B

U3

where the budget line is at a tangent to an IC Points B and E are also affordable

C U3 E BL U1 Burger
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but give lower utility, being on a lower IC.

U2

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Marginal Utility Approach -- How does it work?

For any two goods Burger and French Fries , with prices P1 and P2, whenever MUB / P1 > MUFF / P2, a consumer is made better off shifting away from FF and toward Burger A utility-maximizing consumer will choose the point on the budget line where marginal utility per dollar is the same for both goods (MUB / P1 = MUFF / P2) =- MUB/MUFF=x1/x2=MRS= - P1 / P2 MUB / P1 = MUFF / P2 At that point, there is no further gain from reallocating expenditures in either direction Utility will be maximized where MUX / PX = MUY / PY for any pair of goods x and y
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Maximization of Utility( Mathematically )

Utility function=U=f(x1,x2) Budget function P1 * X 1+ P2 * X2 = m Consumer desire to maximize utility subject to budget constraint Lagrange function=Z=f(x1,x2)+( m-P1 * X 1 - P2 * X2 ) First-Order Condition: Setting the first partial derivatives of respect to x1,x2 and (undetermined multiplier) z/x1 = f1-P1=0 z/x2 = f2-P2=0 z/= m-P1 * X 1 - P2 * X2 =0 From 1st two equations we get, f1/f2=P1/P2 = the ratio of the marginal utilities equal to ratio of prices for a maximum Marginal utility divided by price must be the same for all commodities. f1/P1=f2/P2= , the Lagrange multiplier can be interpreted as the marginal utility of income Second-Order Condition must satisfied to ensure , maximum is actually reached. (2f12f1f2-f11f22-f22f12 )>0
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Date:21.05.2010 Place: Bangalore

Great news! MacDonald How does change in has reduce the Burger Burger price Rs.25 to Rs.20 price from decide the consumption of French Fries and Burger? Oh really! It is a good news. So now, will you eat more Ok French Fries or Burger? . See the magic Raj

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Price Changes in the Budget Line

while a decrease in the price of Burger rotates it rightward (Purchasing power increase) Altering its slope Which reflects relative prices Burger price drops from Rs.25 to Rs20( consumer can buy more Burger at same income level)

FFs 20

10

4
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Burger
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An decrease in the price of Burger

U2 The consumer moves from the original choice point E to a new position at C. C E BL0 U1 BL1 U2

FFs

U1

Burger

Tracing out more of such points at different prices enables us to identify the Demand curve.
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Response to a price change

The response to a price change comprises two effects: The SUBSTITUTION EFFECT is the adjustment to the change in relative prices THE INCOME EFFECT is the adjustment to the change in real income.

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The substitution effects

U2

U1 U2 H BL0 U1 BL1

The hypothetical budget line HH has the slope of the NEW relative prices and is tangent to the OLD indifference curve The SUBSTITUTION EFFECT is from E to D along U1U1 It is always negative a price decrease leads to a increase in demand

FFs

H E D

Burger
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The income effect

The INCOME EFFECT is from D to C
U2 U1

it reflects the increase in real income at constant relative prices

C

FFs

H E D

it may be positive or negative

U2 U1 BL1

H BL0
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depending on whether the good is normal or inferior

Burger
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Deriving the Demand Curve

Number of 10 FFs 6 5 4 0 Price per 30 Burger 2 D 1. When the price of Burger is Rs.30, point D is best for Max. K D J 2. If the price falls to Rs.10, Max's budget line rotates rightward, and he choose point J.

10

20 3. And if the price drops to Rs.5, he chooses point K.

10 5 2
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J 5 8

4. The demand curve shows the quantity Max chooses at each price. Number of Burgers
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In economics, demand is the desire to own anything and the ability to pay for it and willingness to pay. The term demand signifies the ability or the willingness to buy a particular commodity at a given point of time. Economists record demand on a demand schedule and plot it on a graph as an inverse (downward sloping) demand curve. The inverse curve reflects the relationship between price and quantity demanded: as price decreases, quantity demanded increases. The demand curve is equal to the marginal utility (benefit) curve. If there are no externalities, the demand curve is also equal to the social utility (benefit) curve

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Date:21.06.2010 Place: Bangalore

Thank you Neel You are most Welcome Raj

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