1373573795Consumer Behaviour

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  7 IN THIS CHAPTER YOU WILL LEARN:1 About total utility, marginal utility, and the law of diminishing marginal utility.2 How rational consumers compare marginal utility-to-price ratios for products in purchasing combinations of products that maximize their utility.3 How a demand curve can be derived by observing the outcomes of price changes in the utility-maximization model.4 How the utility-maximization model helps highlight the income and substitution effects of a price change.5 (Appendix) About budget lines, indifference curves, utility maximization, and demand derivation in the indifference curve model of consumer behavior. 134  Consumer Behavior If you were to compare the shopping carts of almost any two consumers, you would observe strikingdifferences. Why does Paula have potatoes, peaches, and Pepsi in her cart while Sam has sugar, sal-ines, and 7-Up in his? Why didn’t Paula also buy pasta and plums? Why didn’t Sam have soup and spaghetti on his grocery list? In this chapter, you will see how individual consumers allocate their incomes among the variousoods and services available to them. Given a certain budget, how does a consumer decide whichgoods and services to buy? As we answer this question, you will also strengthen your understandingf the law of demand.  CHAPTER 7 Consumer Behavior 135  Law of Diminishing Marginal Utility  The simplest theory of consumer behavior rests squarely on the law of diminishing marginal utility  . This princi-ple, first discussed in Chapter 3, is that added satisfactiondeclines as a consumer acquires additional units of a givenproduct. Although consumer wants in general may be in-atiable, wants for particular items can be satisfied. In apecific span of time over which consumers’ tastes remain unchanged, consumers can obtain as much of a particular good or service as they can afford. But the more of that product they obtain, the less they want still more of it.Consider durable goods, for example. A consumer’s desire for an automobile, when he or she has none, may be very strong. But the desire for a second car is less intense;and for a third or fourth, weaker and weaker. Unless they are collectors, even the wealthiest families rarely have ore than a half-dozen cars, although their incomes wouldallow them to purchase a whole fleet of vehicles. Terminology Evidence indicates that consumers can fulfill specific wants  with succeeding units of a product but that each added unit provides less utility than the last unit purchased. Recall that a consumer derives utility from a product if it can satisfy a want: tty  is want-satisfying power. Theutility of a good or service is the satisfaction or pleasureone gets from consuming it. Keep in mind three charac-eristics of this concept:ã“Utility” and “usefulness” are not synonymous. Paintings by Picasso may offer great utility to art connoisseurs but are useless functionally (other than for hiding a crack on a wall). ã Utility is subjective. The utility of a specific product may vary widely from person to person. A lifted pickup truck may have great utility to someone whodrives off-road but little utility to someone unable or unwilling to climb into the rig. Eyeglasses havetremendous utility to someone who has poor eyesight but no utility to a person with 20-20 vision. ãUtility is difficult to quantify. But for purposes of illustration we assume that people can measure atisfaction with units called utils   (units of utility).For example, a particular consumer may get 100 utils of satisfaction from a smoothie, 10 utils of atisfaction from a candy bar, and 1 util of satisfaction from a stick of gum. These imaginary units of atisfaction are convenient for quantifying consumerbehavior for explanatory purposes. Total Utility and Marginal Utility  Total utility and marginal utility are related, but different,ideas. ota utty  is the total amount of satisfaction orpleasure a person derives from consuming some specificquantity—for example, 10 units—of a good or service. argna utty  is the extra satisfaction a consumer realizes from an additional unit of that product—for example, from the eleventh unit. Alternatively, marginalutility is the change in total utility that results from the consumption of 1 more unit of a product. Figure .1(Key Graph)  and the accompanying table demonstrate the relation between total utility and marginal CONSIDER THIS . . . Vending Machines and Marginal Utility Newspaper dispensing devices and soft-drink vending machinesare simiar in teir asic opera-tions. ot enae consumers to buy a product by insertingcoins. But there is an importantifference in the two devices. e newspaper ispenser opensto the full stack of papers and seemingly trusts” the customer to tae ony a singe copy, whereas the vending machine displays no such trust, requiring the consumer to buy one can at a time. Why the difference?The idea of diminishing marginal utility is key to solving this puzzle. Most consumers take only single copies from the news-paper box because the marginal utility of a second newspaper is nearly zero. They could grab a few extra papers and try to sell tem on te street, ut te revenue otaine wou e sma relative to their time and effort. So, in selling their product, newspaper publishers rely on “zero marginal utility of the sec-nd unit,” not on consumer honesty.” Also, newspapers have little “shelf life”; they are obsolete the next day. In contrast, soft-rin seers o not aow uyers to mae a singe payment anthen take as many cans as they want. If they did, consumerswould clean out the machine because the marginal utility of successive cans of soda diminishes slowly and buyers could take extra sodas and consume them later. Soft-drink firms thus vendtheir products on a pay-per-can basis.In summary, newspaper publishers and soft-drink firms use al-ternative vending techniques because of the highly different ratesf decline in marginal utility for their products. The newspaper seller uses inexpensive dispensers that open to the full stack of papers. The soft-drink seller uses expensive vending machines thatimit te consumer to a singe can at a time. ac vening tec-nique is optima uner te particuar economic circumstance.  .  argna utty:  a.  is te extra output a firm otains wen it as anoter unit of aor.  . explains  wh y product supply  curves slope upward.  . typicay rises as successive units of a goo are consume.  . is te extra satisfaction from te consumption of 1 more unit of some good or service. .  Margina utiity in Figure 7.1 is positive, ut ecining, wentota utiity in Figure 7.1a is positive an:  a. rsng at an ncreasng rate.  b. falling at an increasing rate.  . rising at a ecreasing rate.  . faing at a ecreasing rate. . en margna utty s zero n grap , tota utty n grap(a) is:  . aso zero.  . neither rising nor falling.  . negatve.  . rising, ut at a ecining rate. 4. Suppose te person represente y tese graps experience adiminished taste for tacos. As a result the:  .  TU curve wou get steeper.  .  MU curve wou get fatter.  c.  TU and MU curves would shift downward.  .  MU curve, ut not te TU curve, wou coapse to te ori-zonta axis.    A  n  s   w  e  r  s :  1 .  d ;  2 .  c ;  3 .  b ;  4 .  c graph key 30201001234567 TU  (a)Total utility    T  o  t  a   l  u  t   i   l   i  t  y   (  u  t   i   l  s   ) MU 10842  –  201234567Units consumed per meal(b)Marginal utility    M  a  r  g   i  n  a   l  u  t   i   l   i  t  y   (  u  t   i   l  s   ) FIGURE 7.1 otal and marginal utility.  Curves TU and MU are graphed fromthe data in the table. (a) As more of a product is consumed, total utility increases at adiminishing rate, reaches a maximum, and then declines. (b) Marginal utility, by definition, reflects the changes in total utility. Thus marginal utility diminishes with increased consumption, becomes zero when total utility is at a maximum, and is negative when total utility declines. As shown by the shaded rectangles in (a) and (b), marginal utility is the changein total utility associated with each additional taco. r, alternatively, each new level of total utility is found by adding marginal utility to the preceding level of total utility.  (1) (2) (3) Tacos Total Marginal Consumed Utility, Utility, per Meal Utils Utils  0 0 ]————–     10 1 10 ]———–—  8 2 18 ]——–——  6 3 24 ]—–———  4 4 28 ]–————  2 5 30 ]—————  0 6 30 ]————–     –2 7 28 QUICK QUIZ FOR FIGURE 7.1 136  CHAPTER 7 Consumer Behavior 137 utility. The curves reflect the data in the table. Column 2shows the total utility associated with each level of con-sumption of tacos. Column 3 shows the marginal utility—he change in total utility—that results from the consumption of each successive taco. Starting at the srcin in Figure 7.1a, observethat each of the first fiveunits increases total util-ity (TU), but by a dimin-ishing amount. Total utility reaches a maximum with the addition of the sixth unit and then declines. So in Figure 7.1b marginal utility (MU) remains posi-ive but diminishes through the first five units (because totalutility increases at a declining rate). Marginal utility is zerofor the sixth unit (because that unit doesn’t change total utility). Marginal utility then becomes neg-ative with the seventh unit and beyond (because total utility is falling). Figure 7.1band table column 3 reveal that each successive taco yieldsless extra utility, meaning fewer utils, than the preceding aco as the consumer’s want for tacos comes closer and closero fulfillment. 1  That is, the table and graph illustrate the law of diminishing marginal utility. Key Question 1  Marginal Utility and Demand  The law of diminishing marginal utility explains why thedemand curve for a given product slopes downward. If successive units of a good yield smaller and smaller amounts of marginal, or extra, utility, then the consumer  will buy additional units of a product only if its price falls.  The consumer for whom Figure 7.1 is relevant may buy  wo tacos at a price of $1 each. But because he or she obtains less marginal utility from additional tacos, the consumer will choose not to buy more at that price. Theconsumer would rather spend additional dollars on products that pro- vide more utility, not less utility. Therefore, additional acos with less utility are not worth buying unless the pricedeclines. (When marginal utility becomes negative, Taco Bell would have to pay you to consume another taco!)  Thus, diminishing marginal utility supports the idea that price must decrease in order for quantity demanded toincrease. In other words, consumers behave in ways that ake demand curves downward-sloping. G 7.1 Total and marginal utility INTERACTIVE GRAPHS O 7.1 Diminishing marginal utility ORIGIN OF THE IDEA 1  Technical footnote: In Figure 7.1b we graphed marginal utility at half-units. For example, we graphed the marginal utility of 4 utils at 3 1 unitsecause “4 utils” refers neither to the third nor the fourth unit per se but to the addition  or  subtraction  of the fourth unit. QUICK REVIEW 7.1 ã Utiity is te enefit or satisfaction a person receives from onsuming a good or a service.ã  The la w of diminishing marginal ut ilit  y indicates that gains  specific prouct are consume. ã Diminising margina utiity provies a simpe rationae forhe la w of eman.  Theory of Consumer Behavior In addition to explaining the law of demand, the idea of diminishing marginal utility explains how consumersallocate their money incomes among the many goods andservices available for purchase. Consumer Choice and Budget Constraint For simplicity, we will assume that the situation for the typical consumer has the following dimensions.ã  Rational behavior   The consumer is a rational person, who tries to use his or her money income to derivethe greatest amount of satisfaction, or utility, from it.Consumers want to get “the most for their money”or, technically, to maximize their total utility. They engage in rationa eavior. ã  Preferences   Each consumer has clear-cut preferences for certain of the goods and services that are availablein the market. Buyers also have a good idea of how much marginal utility they will get from successive units of the various products they might purchase.ã  Budget constraint   At any point in time the consumer has a fixed, limited amount of money income. Sinceeach consumer supplies a finite amount of humanand property resources to society, he or she earns only limited income. Thus, as noted in Chapter 1,every consumer faces a budget constraint, even consumers who earn millions of dollars a year. Of course, this budget limitation is more severe fora consumer with an average income than for a consumer with an extraordinarily high income.ã  Prices  Goods are scarce relative to the demand forthem, so every good carries a price tag. We assume that the price of each good is unaffected by the amount of it that is bought by any particular person. After all, eachperson’s purchase is a tiny part of total demand. Also,because the consumer has a limited number of dollars, he or she cannot buy everything wanted. This point drives home the reality of scarcity to each consumer.