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06 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 6-2 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 6-3 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 6-4 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 6-5 Theory of Consumer Behavior • Rational behavior • Preferences • Budget constraint • Prices LO2 6-6 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 6-7 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 6-8 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 its relative expensiveness 6-9 Prospect Theory • How people actually deal with life’s • • ups 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 6-10 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 6-11 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 6-12 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 6-13