Download Consumer Behavior

This is a PowerPoint presentation on consumer
behavior and demand.
A left mouse click or the enter key will add and element
to a slide or move you to the next slide. The back space
key will take you back an element or slide. If you wish to
exit the presentation, the escape key will do it!
R. Larry Reynolds 1997
Consumer Objectives
· In the Neoclassical economics, the goal of
consumer behavior is utility maximization
[this is consistent with maximization of
Net benefits]
· Consumer choice among various
alternatives is subject to constraints:
· income or budget
· prices of goods purchased
· preferences
Fall ‘ 97
Principles of Microeconomics
Slide -- 2
Models of Consumer Behavior
· Marginal Utility approach
· cardinal measure of utility
· problem of related goods
· Indifference approach
· ordinal utility
· related goods
· observable behavior
Fall ‘ 97
Principles of Microeconomics
Slide -- 3
Utility Approach to Consumer Behavior
· Need for cardinal measure of utility
· analysis is useful for explaining
behavior
· Total and Marginal utility
· “law of diminishing Marginal Utility”
· Equimarginal rule and utility
maximization
Fall ‘ 97
Principles of Microeconomics
Slide -- 4
Total utility [TU] is defined as the amount of utility an
individual derives from consuming a given quantity of a good
during a specific period of time. TU = f(Q, preferences, . . .)
Utility
TU
Q
TU
120
100
2
30
55
75
60
1
3
4
5
6
90
7
100
105
105
8
100
Fall ‘ 97
80
40
20
.
1
.
2
Principles of Microeconomics
.
3
.
.
.
.
.
TU
4
5
6
7 Q/ut
Slide -- 5
Nature of Total Utility
· When more and more units of a good are consumed
in a specific time period, the utility derived tends
to increase at a decreasing rate
· Eventually, some maximum utility is derived and
additional units cause total utility to diminish. As
an example, think of eating “free” hot cakes.
· It is possible for total utility to initially increase
at an increasing rate.
Fall ‘ 97
Principles of Microeconomics
Slide -- 6
Marginal Utility
· Marginal utility [MU] is the change in total utility
associated with a 1 unit change in consumption.
· As total utility increases at a decreasing rate,
MU declines.
· As total utility declines, MU is negative
· When TU is a maximum, MU is 0 [This is
sometimes called the “Satiation point” or the point
of “absolute diminishing utility.”
Fall ‘ 97
Principles of Microeconomics
Slide -- 7
Marginal Utility [MU] is the change in total utility [DTU]
caused by a one unit change in quantity [DQ] ;
MU = DTU
DQ
Utility
DQ=1
DQ=1
DQ=1
Fall ‘ 97
Q
TU MU
1
2
3
4
5
6
7
8
30
55
DTU=25
75
20
90
100
105
105
100
DTU=30
30
25
DTU=20
15
10
5
0
-5
The first unit consumed increases TU by 30.
MU
The 2cd unit increases TU by 25.
30
25
20
..
10
..
1DQ2
3
4
.. .
MU
5
6
7
.
Q/ut
Remember that the MU is associated with the
midpoint between the units as each additional
unit is added.
Principles of Microeconomics
Slide -- 8
TU
The first unit consumed, DQ
120 increases TU by 30, DTU.
100 max TU
80
60
.
DQ
40
20
20
.
.
.
.
.
[Using calculus, MU is the change in TU
as change in quantity approaches 0.]
between the 2cd and 3rd
units DTU = 20 or the
slope of TU is 20.
For the first unit:
DTU
MU
30
.
.
The MU is the slope of TU or the
TU rate of change in TU associated
with a one unit change in quantity.
1
2
..
10
1
Fall ‘ 97
2
3
4
..
3
4
5
6
7
Q/ut
. .MU
..
5
6
7
30
DTU
MU =
=
DQ
1
DTU
The slope of TU is
= 30,
DQ
MU is the slope of the TU.
The second unit changes TU [ DTU] by
25, The slope of TU between the 1 and
second unit is 25.
Where MU = 0, TU is a maximum.
Q/ut
Principles of Microeconomics
Slide -- 9
Consumer Preferences
·
·
·
·
Both MU and TU are determined by the “preferences” or
utility function of the individual and the quantity consumed.
Utility cannot be measured directly but individual choices
reveal information about the individual’s preferences
Surrogate variables [age, gender, ethnic background,
religion, etc.] may be correlated with preferences.
There is a tendency for TU to increase at a decreasing rate
[MU declines] as more of a good is consumed in a given time
period: i.e. “diminishing marginal utility”
Fall ‘ 97
Principles of Microeconomics
Slide -- 10
Diminishing Marginal Utility
· Initially, it may be possible for TU to increase at
an increasing rate. In which case MU will increase
[MU is the slope of TU which is increasing].
· Eventually, as more and more of a good are
consumed in a given time period, TU continues to
increase but at a decreasing rate; MU decreases.
· This is called the point of “diminishing marginal
utility.”
Fall ‘ 97
Principles of Microeconomics
Slide -- 11
Consumer Choices
· If there were no costs associated with choices,
the individual will consume a good until MU = 0 [this
maximizes TU or the total benefits, TB]
· Typically, individuals are constrained by a budget
[or income] and the prices they pay for the goods
they consume.
· Net benefits are maximized where MB = MC; as
long as the MU or MB of the next unit of good purchased exceeds
the Price or MC, it will increase net benefits
Fall ‘ 97
Principles of Microeconomics
Slide -- 12
Society and Individual
· The individual will purchase more of a good so long
as their perceived or anticipated MB exceeds the
price they must pay for the good: Buy so long as
MB > P, optimum where, P = MB
· From a social perspective that good should only be
produced and sold if the price is greater than or
equal to the MC: Sell so long as P > MC, optimum
where P = MC
· Social optimum when MB = P = MC
Fall ‘ 97
Principles of Microeconomics
Slide -- 13
Constrained Optimization
· Individual choices then become a function of the
price of the good, income [budget], prices of
related goods and preferences.
· QX = f (PX , Y, PY, Preferences, . . . )
·
·
·
·
Where:
PX = price of good X
Y = income
PY = prices of related goods
· “preferences” is the individual’s utility function
Fall ‘ 97
Principles of Microeconomics
Slide -- 14
Utility and Demand
· Individual choice is influenced by:
· QX = f (PX , Y, PY, Preferences, . . . )
· These are the same variables in the
demand function
· The forces that shape the demand
function can be analyzed with utility
analysis
Fall ‘ 97
Principles of Microeconomics
Slide -- 15
B > PxQx + PyQy
The budget constraint can be expressed:
The amount of good Y that can be purchased
is the budget divided by the price of good Y,
The amount of good X
that can be purchased
is,
B
Px
Qy
B
80
= 16 =
Py
5
Connecting the two intercepts
identifies all combinations of
goods X &Y that can be
purchased for a budget of $80,
Py = $5, and PX = $3.
0
Fall ‘ 97
B
Py
For an B = $80,
and Py = $5
For an B = $80,
and PX = $3
C
Any combination
inside area 0AC
can be purchased
for less than $80.
B
80
= 26.7 =
Px
3
Principles of Microeconomics
A
Qx
Slide -- 16
Consider an individual’s utility preference for 2 goods, X & Y;
Good X
Utility X
Qx
1
2
3
4
5
6
TUx MUx
30
55
30
25
75 20
90
7
100
105
105
8
100
Fall ‘ 97
15
10
5
0
-5
If the two goods were “free,”
[ or no budget constraint],
the individual would consume
each good until the MU of
that good was 0, 7 units
of good X and 6 of Y.
Once the goods have a price
and there is a budget
constraint, the individual
will try to maximize the
utility from each additional
dollar spent.
Principles of Microeconomics
Good Y
Utility Y
Qy
1
2
3
4
TUy MUy
60
90
60
30
110
20
120
10
5
6
128
7
120
8
100 - 20
128
8
0
-8
Slide -- 17
Given the budget constraint, Individuals will attempt to
gain the maximum utility for each additional dollar spent,
“the marginal dollar.”
Utility X
Qx
1
2
3
4
5
6
TUx MUx
30
55
30
25
75 20
90
7
100
105
105
8
100
Fall ‘ 97
15
10
5
0
-5
MUX
PX
10.
8.33
For PX = $3, the
MUX per dollar
spent on good
X is;
For PY = $5, the
6.67 MUY per dollar
5.00 spent on good
Y is;
3.33
1.67
0
Principles of Microeconomics
MUY
PY
Utility Y
Qy
12
1
6
2
4
3
4
2
1.6
0
5
6
TUy MUy
60
90
60
30
110
20
120
10
7
128
128
120
8
0
-8
8
100 - 20
Slide -- 18
Now the preferences of the individuals and the relative prices
of the two goods are displayed in the tables.
Utility X
Qx
1
2
3
4
5
6
TUx MUx
30
55
30
25
75 20
90
7
100
105
105
8
100
Fall ‘ 97
15
10
5
0
-5
MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
MUY
PY
If the objective is
to maximize utility
given prices,
preferences, and
budget, spend each
additional $ on the
good that yields
the greater utility
for that
expenditure.
Principles of Microeconomics
Utility Y
Qy
12
1
6
2
4
3
4
2
1.6
0
5
6
TUy MUy
60
90
60
30
110
20
120
10
7
128
128
120
8
0
-8
8
100 - 20
Slide -- 19
Given the preferences of the individual and the relative
prices of the goods [PX = $3, PY = $5], the MU’s for
each dollar spent are:
To maximize TU given a budget of $30,the first
expenditure would logically be for good Y since
the MUY for each dollar is 12.
MUX
PX
10.
8.33
$3
$3
6.67
$3
$3
5.00
3.33
1.67
0
$3
The second expenditure is for good X,
[MUX $ is greater than MUY $]





The third & fourth expenditures are for
good X since the MU per dollar spent is
greater for X than Y.
MUY
PY
$5



$5
$5
The fifth expenditure is for is for good Y.
Continue to maximize the MU per $ spent.
AT THIS POINT YOU HAVE SPENT THE BUDGET OF $30.
MUY
MUX
MUY
MUX
PX
Fall ‘ 97
>P
Y
, BUY X !
PX
<P
Principles of Microeconomics
Y
, BUY Y !
Slide -- 20
12
6
4
2
1.6
0
MUX
PX
>MU
P
MUX
PX
<MU
P
Y
Y
Y
Y
says that the marginal utility of an additional
dollar spent on good X is greater than that of
a dollar spent on good Y.
indicates that the MU per dollar spent on good
Y exceeds that of a dollar spent on good X.
If the amount spent on the two goods is equal to the budget
then
MUX MUY suggests that the individual should buy
PY less of Y in order to buy more of X.
PX
>
MUX
PX
<MU
P
Y
Y
says to purchase less X to pay for additional
amounts of Y.
MUX
MUY
is an equilibrium condition!
PX = PY
Fall ‘ 97
Principles of Microeconomics
Slide -- 21
MUX
MUY subject to the constraint:
P X = PY
PX X + PY Y = B
insures the individual has maximized their total utility and
has not spent more on the two goods than their budget.
This model can be expanded to include as many goods as
necessary:
MUX
MUY
MUZ
= P
PX = PY
Z
= . . . =
subject to;
MUN
PN
PX X + PY Y + Pz Z + . . . + PN N = B
From this information a demand for the goods can be
constructed.
Fall ‘ 97
Principles of Microeconomics
Slide -- 22
Given the preference functions for goods X and Y,
and the prices of the two goods: PX = $3, PY = $5.
the MU of derived
from each dollar
MUY
Utility X MUX of expenditure
Utility Y
PX
PY
can be calculated.
Qy TUy MUy
Qx TUx MUx
1
2
3
4
5
6
30
55
30
25
75 20
90
7
100
105
105
8
100
Fall ‘ 97
15
10
5
0
-5
10.
If the individual is
8.33 maximizing utility,
6.67 their choices,
constrained by
5.00
their preferences,
3.33 the prices and
1.67 their budget can
be shown:
0
Principles of Microeconomics
12
1
6
2
4
3
4
2
1.6
0
5
6
60
90
60
30
110
20
120
10
7
128
128
120
8
0
-8
8
100 - 20
Slide -- 23
Given preferences, prices [PX = $3, PY = $5] and
budget [$30], the individual’s choices were:
MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
Five units of X and 3 units of Y were purchased
These choices can be shown in the context of
a demand model:
$3
 $5

PX 5
$3
 $5

$3
4

 $5
$3

PX = 3
This point lies on the
$3

2
demand for good X.
.
1
At PX = $3,
given budget,
Py and preferences,
1 2
5 units of X are purchased.
Fall ‘ 97
3
4
55
Principles of Microeconomics
6
7
QX/ut
Slide -- 24
MUY
PY
12
6
4
2
1.6
0
Given the individual’s preferences, the price of Y [PY]
and the budget [B = $30], the individual purchased
5 units of X when the price of X [PX ] was $3.
MU
MUXX
PPXX
MUX
PX
[$3]
[$5]
[$5]
10. 6
8.33
5
$5 6 
$5 5 
6.67
4
5.00
3
$5 4 
3
3.33
2
1.671
0 0
Raise the price of X [PX ] to $5 and the MUX per
$ spent is reduced.
2
1
MU
0X
PX =
Fall ‘ 97
.
Choices about spending the $30 are now:
PX
5
4
3
2
MUY
PY
The $30 is now spent.
1
.
Demand
That
portion
of demand
between $3 and $5
is mapped!
1
2
3
4
5
Principles of Microeconomics



$5
12
$5
6
$5
4
At PX = $5,
ceteris paribus,
3 units of X are
purchased.
6
7
MUY
PY
QX/ut
Slide -- 25
2
1.6
0
Demand
· By continuing to change the price of good X
[and holding all other variables, PY , budget or
income and preferences constant,] the rest of
the demand for good X can be mapped.
· All price and quantity combinations on the
demand for X are equilibrium points for
the consumer [They are maximizing utility;
holding all other variables, PY , budget or income
and preferences constant]
Fall ‘ 97
Principles of Microeconomics
Slide -- 26
By changing the price of the good [in this case, good X] and
holding all other variables [PY , budget or income and
preferences] constant, the demand for the good can be
mapped.
The demand function
is a schedule of the P
X
quantities that
individuals are willing 5
and able to buy at a
4
schedule of prices
3
during a specific
2
period of time,
ceteris paribus.
1
1
Fall ‘ 97
2
3
Principles of Microeconomics
4
5
6
7
QX/ut
Slide -- 27
The demand function has a negative slope because of the
income and substitution effects.
Income effect: As the price of a good that you buy increases
and money income is held constant, your real income decreases
and you can not afford
to buy as much as you
PX
could before.
Substitution effect: As
the price of one good rises
relative to the prices of
other goods, you will tend
to substitute the good
that is relatively cheaper
for the good that is
relatively more expensive.
5
4
3
2
1
1
Fall ‘ 97
2
3
Principles of Microeconomics
4
5
6
7 QX/ut
Slide -- 28
Income effects
· As the price of a good that you buy
increases, you will have less real income.
· This is the basis of price indices that
measure changes in real income as prices
rise or fall.
· The consumer price index is one of the
indices that is used [currently there is a
debate about how it is calculated].
Fall ‘ 97
Principles of Microeconomics
Slide -- 29
Substitution Effects
· As the price of a good increases
[decreases] while the prices of other
goods is constant, it becomes
relatively more [less] expensive.
· Individuals would substitute relatively
less expensive goods for relatively
more expensive ones even if their
real income were constant.
Fall ‘ 97
Principles of Microeconomics
Slide -- 30
CONSUMER SURPLUS
Notice that someone is willing and able to pay $6.80 for the
first unit. If the market price [established by S and D]
were $3, the buyer would purchase at $3 even though they
were willing to pay
$6.80 for the first unit. PX
7
They receive utility
6.80
that they did not have
6
to pay for [6.80-3.00].
5
This is called consumer
4
surplus.
At market equilibrium,
Consumer surplus will be
the area above the market
price and below the demand
function.
Fall ‘ 97
.
consumer
surplus
3
2
1
1
2
3
Principles of Microeconomics
4
5
6
7
QX/ut
Slide -- 31
Demand
· Demand functions can be derived from utility
[cardinal measures] or indifference functions
[ordinal measures]
· Normally, demand functions show and inverse
relationship between price and quantity
· a change in price “causes” a change in “quantity
demanded”
· a change in any other variable [income, prices of
related goods, population, preferences, . . .] will
“cause a change in demand” or shift of demand
Fall ‘ 97
Principles of Microeconomics
Slide -- 32