Business Economics 04 Consumer Behaviour
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Transcript of Business Economics 04 Consumer Behaviour
Discussion
Utility - Cardinal and Ordinal Total utility and marginal utility Indifference curve analysis Revealed preference theory - concept Using the characteristics for demand analysis-
concept
Behavioral perspectives on decision making
Utility – subjective, post consumption satisfaction, user specific, ethically neutral, changes with time, perception and income.
Cardinal utility (Jevons, Menger, Walras, Marshall)
Ordinal utility (Slutsky, Pareto, John Hicks)
Principle of diminishing marginal utility
As a person continues the consumption of a good with ceteris paribus condition, the total satisfaction derived will increase but at decreasing rate.
Neha’s utility from consuming crisps (daily)
Packets of crisps
consumedTU in utils MU in
utils
0 0 0
1 7 7
2 11 4
3 13 2
4 14 1
5 14 0
6 13 -1
The ceteris paribus assumptions
Are there any goods or services where consumers do not experience diminishing marginal utility?
Utility/welfare measurements
Consumer surplus - the excess of what a person would have been prepared to pay for a good (i.e. the utility) over what that person actually pays
Marginal consumer surplus - the excess of utility from the consumption of one more unit of a good (MU) over the price paid :
MCS = MU - P
Total consumer surplus - the excess of a person’s total utility from the consumption of a good (TU) over the amount that a person spends on it (TE):
TCS = TU - TE
Rational consumer behavior - people will go on purchasing additional units as long as they gain additional consumer surplus (MU>P)
Optimum level of consumption - MU = P
If a good were free, what would be the level of consumer surplus?
MU and demand curve
Water-Diamond Paradox
What determines the market value of a good?
Karl Marx and David Ricardo- value depends on the amount of resources used
Adam Smith (1760s) – ‘How is it that Water which is so essential to human life, and thus has such a high ‘value-in-use’, has such a low market value? And how is that diamonds which are relatively so trivial have such a high market value?’
MU revolution in 1870s - Jevons(UK) Carl Mager(Austria) and Walras(Switzerland) claimed that the source of market value is its MU, not its TU.
Diminishing marginal utility of income- moral argument for redistributing income
Drawbacks
Weaknesses of the one commodity version of marginal utility theory
Effects on substitutes and complimentary goods and leftover income
Constant marginal utility of money
The Equi-marginal Utility Principle- the optimum combination of goods consumed - consumer will get the highest utility from a given level of income when the utility from the last re.1 spent on each good is the same.
Suppose Px=2/- and Py=2/-, I=20/-, and he spends it all on X and Y.
1. State the equilibrium for this individual2. If “commodity” Y is savings, how would the
equilibrium condition be affected3. Suppose that MUx increased continuously as the
individual consumed more of X while MUy remains constant, how should the consumer rearrange his expenditure to maximize utility
ExerciseQ 1 2 3 4 5 6 7 8 9 10 11
Mux 15 14 11 10 9 8 7 6 5 3 1
Muy 15 13 12 8 6 5 4 3 2 1 0
Ordinal utility- Indifference curve analysis Consumer Preferences Budget Constraint
Basic Assumptions Completeness- preferences ignore costs Reflexivity- bundle is as good as others Transitivity- preferences are consistent and
rational More to Less
Indifference curve - a line showing all those combinations of two baskets of goods between which a consumer is indifferent
Characteristics of an ICslopes downward to righttwo ICs cannot intersect each other higher IC gives higher level of satisfactionconvex to origin
Marginal rate of substitution (MRS) between two goods in consumption
Diminishing MRS
Indifference map
Budget constraint
Which of the following diagrams correspond to which
of the following?
Y
O X
Y
O X
a) x and y are left shoes and right shoes.
b) x and y are two brands of the same product, and the consumer cannot tell them apart.
Optimization of satisfaction by consumer
MRSxy = Px/Py
Px/Py = MRSxy = Mux/Muy = X/ Y
Px/Py = Mux/Muy
Mux/Px = MUy/Py
The effect of changes in income
Real income
Income-consumption curve
The effect of change in price
Price-consumption curve
Price effect = Substitution effect + Income Effect
Income effect of a price change
Substitution effect of a price change
Compensating variation – excludes the change in real income
Giffen goods - accounting for large proportion of consumer expenditure which leads to significant effect on the real income resulting in abnormal income effect outweighing normal substitution effect
Application of indifference curve analysis
Choices by consumers
Buy one large pizza, get one large pizza free (limit one free pizza per customer)
Exercise
While at a discount shoe store, a customer asked a clerk, “I see that your shoes are ‘buy one, get one free- limit one free pair per customer: will you sell me one pair for half-price?” The clerk answered, “I can’t do that,” when the customer started to leave the store, the clerk hastily offered, “however, I am authorized to give you a 40% discount on any pair in the store.” Assuming the consumer has Rs.2000/- to spend on shoes (x) or all other goods (y), and that shoes cost Rs.1000/-per pair, answer the following questions:
A) Illustrate the consumer’s opportunity set under the ‘buy one, get one free deal’ and under a 40% discount
B) Why was the 40% discount offered only after the consumer rejected the ‘buy one, get one free’ deal and started to leave the store?
C) Why was the clerk willing to offer a ‘buy one, get one free’ deal but unwilling to sell a pair of shoes for half-price?
Choice by consumer cont.
Gifts – cash or in-kind
Choices by workers and managers
A simplified model of income-leisure choice
Limitations of IC Analysis
Difficult to derive ICs
Consumers may not be rational
Difference between expected satisfaction and gained satisfaction
Not applicable in case of consumer durables
Revealed Preference Theory
Assumptions
•Taste does not change
•Consistency
•Transitivity
•Consumer induced to purchase any basket of goods if its price is made sufficiently attractive.