Consumer Behavior

9

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 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

LO1

Law of Diminishing Marginal Utility

• As consumption of a good or service increases, the marginal utility obtained from each additional unit of the good or service decreases

• Explains downward sloping demand

LO1

Total Utility and Marginal Utility

LO1

0

10

20

30

1086420

-2

1 2 3 4 5 6 7

1 2 3 4 5 6 7

To

tal U

tilit

y (U

tils

)M

arg

inal

Uti

lity

(Uti

ls)

(2)Total

Utility,Utils

(3)MarginalUtility,Utils

0

1

2

3

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5

6

7

0

10

18

24

28

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8

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Total Utility

TU(1)Tacos

ConsumedPer Meal

MU

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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 MU of product B

Price of A Price of B

LO2

=

Deriving the Demand Curve

LO3

Pri

ce

of

Ora

ng

e

0

$1

$2

4 6

Quantity Demanded of Oranges

$2

1

4

6

QuantityDemanded

Price Per Orange

DO

Income and Substitution Effects

• Income effect

• The impact that a price change has on a consumer’s real income

• Substitution effect

• The impact that a change in a product’s price has on its relative expensiveness

LO4

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

Losses and Shrinking Packages

• Consumers see any price increase as a loss relative to the status quo

• Producers are reducing package size instead of raising prices

LO5

Framing Effects and Advertising

• Consumers evaluate events in a particular mental frame

• New information alters the frame in which the consumer defines whether situations are gains or losses

LO5

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