Consumer behavior

The relevanceFor successful exchange outcomeTo understand the impact of micro environment on their decision makingSo as to influence those factors affecting demand

Sequence of discussion

Utility Cardinal Utility ApproachOrdinal Utility Approach- Indifference curve analysisBehavioral 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)

Cardinal utilityTotal utilityMarginal utility

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.

Nehas utility from consuming crisps (daily)

Packets of crisps consumedTU in utilsMU in utils0001772114313241415140613-1

The ceteris paribus assumptionsAre there any goods or services where consumers do not experience diminishing marginal utility?

Utility measurementsConsumer 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 paysMarginal 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 persons total utility from the consumption of a good (TU) over the amount that a person spends on it (TE): TCS = TU - TERational consumer behavior - consumer will go on purchasing additional units as long as she gains additional consumer surplus (MU>P)

Optimum level of consumption - MU = PIf a good is free, what would be the level of consumer surplus?MU and demand curve

Water-Diamond ParadoxWhat determines the market value of a good?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? Karl Marx (Germany) and David Ricardo (UK)- value depends on the amount of resources used

MU revolution in 1870s - Jevons(UK) Carl Menger(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

DrawbacksWeaknesses of the one commodity version of marginal utility theoryEffects on substitutes and complimentary goods and leftover incomeConstant marginal utility of money

The Law of Equi-marginal Utilitythe optimum combination of goods consumed - consumer will get the highest total 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.State the equilibrium for this individualIf commodity Y is savings, how would the equilibrium condition be affectedExercise

Q1234567891011Mux151411109876531Muy15131286543210

Suppose that the MU of 4th unit of Y was 7 rather than 8, what effect would this have on the equilibrium conditionSuppose 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

Ordinal utility- Indifference curve analysisConsumer PreferencesBudget Constraint

Basic AssumptionsCompleteness- preferences ignore costsReflexivity- bundle is as good as othersTransitivity- preferences are consistent and rationalMore to Less

Indifference curve - a line showing all those combinations of two baskets of goods between which a consumer is indifferentCharacteristics 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 mapBudget constraint

Which of the following diagrams correspond to which of the following?x and y are left shoes and right shoes.x and y are two brands of the same product, and the consumer cannot tell them apart.

Optimization of satisfaction by consumer

MRSxy = Px/PyPx/Py = MRSxy = MUx/MUy = X/ YPx/Py = MUx/MUy MUx/Px = MUy/Py

The effect of changes in incomeReal income Income-consumption curveThe effect of change in pricePrice-consumption curve

Price effect = Substitution effect + Income EffectIncome effect of a price changeSubstitution effect of a price change Compensating variation excludes the change in real income

Engel Curve (1821-96)- Indians spend more on education, less on food

1999-2009- food expenditure increased by 70% in rural and 78% in urbanEducation expenditure 378% in rural and 345% in urban63% in rural and 73% in urban people getting their kids educatedMedical care- 152% rise in rural and 136% in urban(NSSO 61st and 66th round reports)

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 analysisChoices by consumersBuy one large pizza, get one large pizza free (limit one free pizza per customer)

ExerciseWhile 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 cant 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 consumers opportunity set under the buy one, get one free deal and under a 40% discountB) 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-kindChoices by workers and managersA simplified model of income-leisure choice

The decision of a managerValuing output and profit bothValuing output onlyValuing profit only

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

AssumptionsTaste does not changeConsistencyTransitivityConsumer induced to purchase any basket of goods if its price is made sufficiently attractive.

The demand for characteristics - Lancasters approach to demand

Goods demanded for their characteristicsA good may possess more than one characteristicsStyle, flexibility, after sales service etc.

The advantagesSubstitute goods explained in terms of possessing some common characteristicsThe introduction of new goodsThe effect of changes in quality

AssumptionsMore than one characteristicMix of characteristics which differs from one product to the nextGood with similar characteristics are possible substituteProduct characteristics measured which is objectiveThe number of products on the market exceeds the number of product characteristics allowing for competition between products.

The two characteristics approachPrice changes brand loyaltyIncome changes - inferior goods and saturationGaps in the market

Mobile operators to launch interactive FM radio services Thomas K Thomas Visuals and song related details among services being offered New Delhi , July 23 Now you can watch visuals while you listen to FM radio on your mobile handset. Mobile operators including Airtel and Hutch are all set to launch a new service called `Visual Radio' which will enable users to get visuals, information and details related to the song and the singer while listening to the radio. The service will also enable users to download the song as ring tone and interact live through quizzes and audience polls. Launch soon While Airtel is ready to launch this service by the end of the month, Hutch is announcing the launch this week. The subscribers do not have to pay any subscription fee for the service for now but once the introductory offer period is over the operators may fix a monthly fee. However, users will have to pay in case they download the song or participate in the interactive services. Both the operators have tied up with Radio Mirchi, Hewlett Packard and Nokia for the service. Services offered Visual Radio offers immediate access to factual content related to the songs playing, the group or the singer playing, their background details, history, related quizzes, participation in audience polls and even the facility to download ring tones and wallpaper related to the song. Mobile users can also buy the tickets for concerts or movies from which the song is being played. "Images and texts are synchronised with the radio broadcast to bring information and interactivity directly to the mobile phone. Research indicates that people listen to 63 minutes of radio on an average day. Can you imagine enhancing their daily experience multiple-fold through the visual medium? That is exactly what we are doing for our Airtel customers. This service is a great example of technologies converging on the mobile and this means that Airtel customers can view related information and other exciting entertainment while listening to their favourite songs," said Mr Sanjay Kapoor, Joint President Mobility, Bharti Airtel Ltd.

Weaknesses of Lancasters model

Not all characteristics can be measured objectively Different consumers may see the same product or brand representing the same characteristics but in different ratios

It is important to learn how different combinations of the characteristics of a product yield more or less satisfactionGoods having similar characteristics may not be substitute for one another consumers choice Suitable incase of divisible and non-durable products.

ExerciseDraw a figure that shows a hypothetical equilibrium for the consumption of honey and sugar and for their two attributes calories and sweetness 33% increase in the consumers income 40% reduction in the price of honey (with no change in the price of sugar and in consumers income)Competitive saccharin is introduced with more of sweetness and less of calories.

(d) How could producers of sugar regain the market?(e) If saccharin is very profitable, what quality changes are producers of honey stimulated to introduce? How would these quality changes be reflected?

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