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9 Consumer Behavior McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Law of Diminishing Marginal Utility • Utility is the satisfaction one gets from consuming a good or service • Not the same as usefulness • Subjective • Difficult to quantify LO1 Law of Diminishing Marginal Utility • Util is one unit of satisfaction or • • LO1 pleasure Total utility is the total amount of satisfaction Marginal utility is the extra satisfaction from an additional unit of the good MU = ΔTU/ΔQ Law of Diminishing Marginal Utility • As consumption of a good or service • LO1 increases, the marginal utility obtained from each additional unit of the good or service decreases Explains downward sloping demand Total Utility and Marginal Utility 0 1 2 3 4 5 6 7 LO1 (2) (3) Total Marginal Utility, Utility, Utils Utils 0 ] 10 ] 18 ] 24 ] 28 ] 30 ] 30 ] 28 10 8 4 2 0 -2 30 TU 20 10 0 6 Marginal Utility (Utils) (1) Tacos Consumed Per Meal Total Utility (Utils) Total Utility 1 2 3 4 5 6 7 1 2 3 4 5 6 7 MU 10 8 6 4 2 0 -2 Theory of Consumer Behavior • Rational behavior • Preferences • Budget constraint • Prices LO2 Utility Maximizing Rule • Consumer allocates his or her income so that the last dollar spent on each product yields the same amount of extra (marginal) utility • Algebraically MU of product A Price of A LO2 = MU of product B Price of B Numerical Example The Utility Maximizing Combination of Apples and Oranges Obtainable with an Income of $10 (2) Apple (Product A): Price = $1 (3) Oranges (Product B): Price = $2 (a) Marginal Utility, Utils (b) Marginal Utility per dollar (MU/Price) (a) Marginal Utility, Utils (b) Marginal Utility per dollar (MU/Price) First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 (1) Unit of Product LO2 Decision-Making Process Sequence of Purchases to Achieve Consumer Equilibrium, Given the data in Table 6.1 Marginal Choice Utility Number Potential Choices per Dollar LO2 Purchase Decision Income Remaining 1 First Apple First Orange 10 12 First orange for $2 $8 = $10 - $2 2 First Apple Second Orange 10 10 First apple for $1 and Second orange for $2 $5 = $8 -$3 3 Second Apple Third Orange 8 9 Third orange for $2 $3 = $5 - $2 4 Second Apple Fourth Orange 8 8 Second apple for $1 and Fourth orange for $2 $0 = $3 - $3 Deriving the Demand Curve Price Per Quantity Orange Demanded $2 4 1 6 Price of Orange $2 $1 DO 0 4 6 Quantity Demanded of Oranges LO3 Income and Substitution Effects • Income effect • The impact that a price change has • LO4 on a consumer’s real income Substitution effect • The impact that a change in a product’s price has on it’s relative expensiveness Applications and Extensions • New products • iPod • Diamond-water paradox • Opportunity cost and time • Medical care purchases • Cash and noncash gifts LO5 Prospect Theory • How people actually deal with life’s up • • and downs People judge things relative to the status quo People experience: • Diminishing marginal utility for gains • Diminishing marginal disutility for losses • People are loss adverse LO5 Losses and Shrinking Packages • Consumers see any price increase as • LO5 a loss relative to the status quo Producers are reducing package size instead of raising prices Framing Effects and Advertising • Consumers evaluate events in a • LO5 particular mental frame New information alters the frame in which the consumer defines whether situations are gains or losses Anchoring and Credit Card Bills • Estimates of value are influenced by • LO5 recent information no matter how irrelevant Can lead to people altering valuations unconsciously Mental Accounting and Warranties • Separate purchases into “mental • LO5 accounts” rather than looking at the big picture Mental accounting exaggerates any potential loss The Endowment Effect • Market transactions may be affected by the endowment effect because: • The seller has a tendency to demand a higher price • The buyer has a tendency to offer a lower price LO5 Nudging People • Using behavioral economics to • • LO5 change people’s behavior Subtle manipulations are used to generate socially better outcomes Unaware of being manipulated