Consumer Choice and Behavioral Economics

1 of 49Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall · Microeconomics · R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.

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The Kindle can download books wirelessly. The Kindle experienced steady sales in

the months following its introduction, and then it

received a huge boost from talk-show host Oprah

Winfrey.

Consumer Choice and Behavioral Economics

CHAPTER 9

Fernando Quijano

Prepared by:


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9.1 Utility and Consumer Decision Making

Define utility and explain how consumers choose goods and services to maximize their utility.

9.2 Where Demand Curves Come From

Use the concept of utility to explain the law of demand.

9.3 Social Influences on Decision Making

Explain how social influences can affect consumption choices.

9..4 Behavioral Economics: Do People Make Their Choices Rationally?

Describe the behavioral economics approach to understanding decision making.

Appendix: Using Indifference Curves and Budget Lines to Understand Consumer Behavior

Use indifference curves and budget lines to understand consumer behavior.

CHAPTER 9Chapter Outline and Learning Objectives

Consumer Choice and Behavioral Economics


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Utility and Consumer Decision Making

The Economic Model of Consumer Behavior in a Nutshell

The economic model of consumer behavior predicts that consumers will choose to buy the combination of goods and services that makes them as well off as possible from among all the combinations that their budgets allow them to buy.

Utility

Utility The enjoyment or satisfaction people receive from consuming goods and services.


9.1 LEARNING OBJECTIVE


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Marginal utility (MU) The change in total utility a person receives from consuming one additional unit of a good or service.

Law of diminishing marginal utility The principle that consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time.

The Principle of Diminishing Marginal Utility




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FIGURE 9-1

Total and Marginal Utility from Eating Pizza on Super Bowl Sunday

The Principle of Diminishing Marginal Utility

The figure shows that for the first 5 slices of pizza, the more you eat, the more your total satisfaction, or utility, increases.

If you eat a sixth slice, you start to feel ill from eating too much pizza, and your total utility falls. Each additional slice increases your utility by less than the previous slice, so your marginal utility from each slice is less than the one before.

Panel (a) shows your total utility rising as you eat the first 5 slices and falling with the sixth slice.

Panel (b) shows your marginal utility falling with each additional slice you eat and becoming negative with the sixth slice. The height of the marginal utility line at any quantity of pizza in panel (b) represents the change in utility as a result of consuming that additional slice.

For example, the change in utility as a result of consuming 4 slices instead of 3 is 6 utils, so the height of the marginal utility line in panel (b) for the fourth slice is 6 utils.




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The Rule of Equal Marginal Utility per Dollar Spent

Budget constraint The limited amount of income available to consumers to spend on goods and services.

Table 9-1

Total Utility and Marginal Utility from Eating Pizza and Drinking Coke

NUMBER OFSLICES OF

PIZZA

TOTAL UTILITYFROM EATING

PIZZA

MARGINAL UTILITY

FROM THELAST SLICE

NUMBER OF CUPS OF

COKE

TOTAL UTILITYFROM

DRINKING COKE

MARGINAL UTILITYFROM THELAST CUP

0 0 -- 0 0 --1 20 20 1 20 202 36 16 2 35 153 46 10 3 45 104 52 6 4 50 55 54 2 5 53 3

6 51 3 6 52 1




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(1)SLICES

OF PIZZA

(2)MARGINAL UTILITY

(MUPIZZA)

(3)MARGINAL

UTILITYPER DOLLAR (4)

CUPSOF COKE

(5)MARGINAL UTILITY

(MUCOKE)

(6)MARGINAL

UTILITYPER DOLLAR

1 20 10 1 20 20

2 16 8 2 15 15

3 10 5 3 10 10

4 6 3 4 5 5

5 2 1 5 3 3

6 3 1.5 6 1

-1

Coke

Coke

P

MU

Table 9-2

Converting Marginal Utility to Marginal Utility per Dollar



Pizza

Pizza

P

MU


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COMBINATIONS OF PIZZA AND COKE WITH EQUAL MARGINAL UTILITIES

PER DOLLAR

MARGINAL UTILITYPER DOLLAR

(MARGINAL UTILITY/PRICE) TOTAL SPENDING TOTAL UTILITY

1 slice of pizza and 3 cups of Coke 10 $2 + $3 = $5 20 + 45 = 65

3 slices of pizza and 4 cups of Coke 5 $6 + $4 = $10 46 + 50 = 96

4 slices of pizza and 5 cups of Coke 3 $8 + $5 = $13 52 + 53 = 105

Table 9-3

Equalizing Marginal Utility per Dollar Spent


We can summarize the two conditions for maximizing utility:

1.

2. Spending on pizza + Spending on Coke = Amount available to be spent

Pizza

Pizza P

MU

Coke

Coke

P

MU




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Solved Problem 9-1Finding the Optimal Level of Consumption

NUMBER OFICE CREAM

CONES

TOTAL UTILITY FROM

ICE CREAM CONES

MARGINAL UTILITY

FROM LAST CONE

NUMBER OFCANS OF LIME FIZZ

TOTAL UTILITY FROM

CANS OF LIME FIZZ

MARGINAL UTILITY FROM

LAST CAN

0 0 -- 0 0 --

1 30 30 1 40 40

2 55 25 2 75 35

3 75 20 3 101 26

4 90 15 4 119 18

5 100 10 5 134 15

6 105 5 6 141 7




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Solved Problem 9-1Finding the Optimal Level of Consumption (continued)

ICE CREAM CONES CANS OF LIME FIZZ

QUANTITY MU MU

1 30 15 40 40

2 25 12.5 35 35

3 20 10 26 26

4 15 7.5 18 18

5 10 5 15 15

6 5 2.5 7 7

YOUR TURN: For more practice, do related problems 1.7 and 1.8 at the end of this chapter.



P

MUP

MU


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Social Influences on Decision Making

The Effects of Celebrity Endorsements

In many cases, it is not just the number of people who use a product that makes it desirable but the types of people who use it.

If consumers believe that media stars or professional athletes use a product, demand for the product will often increase.

Sociologists and anthropologists have argued that social factors such as culture, customs, and religion are very important in explaining the choices consumers make.

Economists have traditionally seen such factors as being relatively unimportant, if they take them into consideration at all.

Recently, however, some economists have begun to study how social factors influence consumer choice.




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Why Do Firms Pay Tiger Woodsto Endorse Their Products?

Makingthe

Connection

The average weekend golfer might believe that if Tiger endorses Nike golf balls, maybe Nike balls are better than other golf balls.

But it seems more likely that people buy products associated with Tiger Woods or other celebrities because using these products makes them feel closer to the celebrity endorser or because it makes them appear to be fashionable.



Tiger Woods earns much more from product endorsements than from playing golf.

YOUR TURN: Test your understanding by doing related problem 3.9 at the end of this chapter.


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Behavioral Economics: Do People Make Their Choices Rationally?

Behavioral economics The study of situations in which people make choices that do not appear to be economically rational.

• They take into account monetary costs but ignore nonmonetary opportunity costs.

• They fail to ignore sunk costs.

• They are unrealistic about their future behavior.

Consumers commonly commit the following three mistakes when making decisions:




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Behavioral Economics: Do People Make Their Choices Rationally?Ignoring Nonmonetary Opportunity Costs

Opportunity cost The highest-valued alternative that must be given up to engage in an activity.

Endowment effect The tendency of people to be unwilling to sell a good they already own even if they are offered a price that is greater than the price they would be willing to pay to buy the good if they didn’t already own it.




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Behavioral Economics: Do People Make Their Choices Rationally?Failing to Ignore Sunk Costs

Sunk cost A cost that has already been paid and cannot be recovered.

Being Unrealistic about Future Behavior

If you are unrealistic about your future behavior, you underestimate the costs of choices that you make today.




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Behavioral economics

Budget constraint

Endowment effect

Law of diminishing marginal utilityMarginal utility (MU)

Utility

KEY TERMS

Consumer Choice and Behavioral Economics

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