CONSUMER CHOICES

1
Chapter 5 CONSUMER CHOICES

2
CONSUMER BEHAVIOR Vital to business decision
making Good anything that adds to human
satisfaction Over supply of a good can
become a BAD Bad detracts from human
satisfaction Consumption goodsdirectly adds to
happiness Services cannot ultimately be
owned Ex car repair, police protection,
medical costs
3
All goods are reduced ultimately to
services Every economic activity has value only
to the extent that it generates useful service
4

• Effects of price changes
• Price goes up people buy less
• Price goes up purchasing power of your
• income shrinks to reduce total income
• to buy goods.
• B. Purchasing patterns with price change
• Substitution effect
• Income effect

5
Substitution effect downward slope along demand
curve that portion of the change in quantity
demanded due solely for a change in
relative price. We substitute some uses for some
goods for similar uses of related goods as
relative price changes
6
Always to your advantage to substitute away
from goods that become relatively more expensive
and to expand equation
7

• II. Income Effect
• adjustments people make because the
• purchasing power of a given income is
• altered when price changes
• If income changes upward you spend more on what
  you are already buying
• If growth of demand causes price to go up, some
  income will go up

8

• UTILITY
• Jeremy Bentham 19th century
• pain and pleasure adds or distracts from
• personal utility or satisfaction
• the greatest pleasure for the greatest number
• Assumed pleasure can be measured
• Do whatever is necessary to maximize total
  utility scores

Utility a numerical indicator of a
persons Preference for some goods compared to
others
9
Higher utility does not mean greater usefulness
it simply means that the Item is preferred to
another item Marginal utility increase
utility. the increase in utility from consuming
an additional unit of a good
10
By maximizing utility, consumers are asked the
consumer is making decisions that lead to the
best outcome in reality, Economists cant
measure utility The utility of different people
can not be compared/ only one product compared
to another
11
Direct Measuring NOT possible 1. Most people
cant specify preferences 2. Cant compare
individuals and their preferences. so
developed indifference analysis Marginal utility
(MU) gain in satisfaction derived through
consumption of a small addition of a good
12
Law of Diminishing Marginal Utility MU
associated with consuming equal successive
units of a good will eventually decline as the
amount consumed increases. CONSUMER EQUILIBRIUM
DEMAND Maximizing Utility 1. Cant compare
different peoples utility for consuming 2. Can
be sure individual MU from particular goods
are proportional to price of the good
13
MUMUc 1 Balancing Utility MUc/ Pc MU
r/Pr1?11 Consumer Equilibrium maximum
utility when last cost spent on each good
yields the same satisfaction as the last spent
on any other goods. Equilibrium allocation of
resources at margin equal advantage principle of
MU per dollar
14
Dollar used as an arbitrary small
denomination of money The higher price good you
purchase, uniformly generates more MU than
lower priced goods
15
Budget Constraints tells us the total
expenditures on all goods and services must be
less than a certain amount limits the
consumers choice depends on the price of the
good
16

• Maximizing Utility Subject to the Budget
• people chose the highest possible level
• of utility given their budget constraints
• Effects of Change in Price
• a. the quantity demanded is less than the
• quantity demanded at the lower price
• b. Higher price leads to a reduced quantity
• demanded
• c. A movement along the demand curve

17
2. Change in Income effect a. decrease in income
leads to a decrease in the amount the consumer
will purchase at each price b. income change
will shift the consumers demand 3. Income
substitution with both an increase in price
leads to a decrease in the quantity demanded
18
Income effect 1. the amount by which quantity
demanded falls because of the decline in real
income 2. Applies to normal goods 3. Less real
income
Substitution effect 1Amount by which the quantity
demanded falls when the price rises
19
Measuring willingness to pay a measure of how
much a consumer would benefit form a different
amount of another good MARGINAL BENEFIT the
increase in benefit from different amounts of
different goods
20

• Graphical derivations
• Demand curve derived from the information
• about willingness to pay marginal benefit
• of the good
• P is greater than marginal benefit/ dont buy !
• Quantity demanded would be 0
• If marginal benefit covers the cost/
• indifference to purchase

21
Individual demand curves slope 1.downward for
this reason 2.as the price lowers, more of the
product is purchased
22
Consumer Surplus is the area below the demand
curve but above the uniform price level 1.
DIFFERENCE BETWEEN A. Max total amount you would
pay to consume a certain quantity of a good as
opposed to B. Having none and the amount you do
pay because you face a uniform price for the
good
23

• Uses of consumer surplus in economics
• Measures how the market system
• is working
• 2. Measures gains to consumers in innovations
• new technology increases consumer surplus
• 3. Evaluate the benefits of govt policies

24

• 2. perspective of demand curves
• quantity demanded depends on the price
• What will people pay for an EXTRA
• unit of a good
• 3. Cant be measured quantitatively
• 4. Can measure qualitative assessments of the
• efficiency of govt policies

25

• Paradox of Value
• absolute value necessities such as water
• are cheap but luxuries such as diamonds are
• are priceless.
• Problem arises in distinguishing Total
• utility from Marginal Utility
• 2. Determines the value and market price of
• individual products

26
Idea of Adam Smith P of marginal benefit is high
for Diamonds P of marginal benefit is low for
water Water has relatively low marginal
benefit total benefit is high Diamonds has
relatively high marginal benefit total
benefit is low
27
The Market Demand Curve sum of the individual
demand curves Different types of individual
curves market curves as smooth where
individuals are NOT Curves will vary at
different locations
28
INFORMATION RATIONAL CHOICE most of the time
people seem to behave as economic models of
demand Goods as bundles of attributes 1. all
goods have utility relevant characteristics 2.
EX cigarettes, oral gratification something to
do with your hands 3. Can never be certain of
the attributes of a specific good
29
4. The less often a good is bought, the less
uncertain exists because of imperfect
information 5. Constant increase in transaction
costs ALL DECISIONS ARRE MADE IN AN ENVIRONMENT
OF RATIONAL IGNORANCE.
30

• Rational Ignorance
• people seek information as long as their
• expected benefits exceed their expected costs
• Consumers choose to be ignorant
• Dont always buy at lower costs
• Too expensive to look
• Propinquity closeness of good
• plays a big role in purchasing
• 4. More choices may confuse

31
5. Substitutes are not always in the same
market EX race horse/nag 6. Assumption that
higher price means higher quality Bewildering
Maze of Choices many choices in advantage of
the market system Many decisions of
rational ignorance seem wrong in retrospect
32
Quality price the price people are willing to
pay is directly related to the perceived quality
of the good EX tip in a restaurant Asymmetric
Information 1. buyers sellers seldom have the
same info. 2. people have different levels of
knowledge about a bargain situation
33

• Two major asymmetric information problems
• 1. Moral Hazard
• transaction for future performance
• Problem inability to predict
• When one party to a contract can
• unexpectedly raise the cost or lower the
• benefits of the other party
• b. Second party cannot monitor or control
• the first
• CHOICES TEND TO REFLECT
• PERSONNEL COSTS BENEFITS

34
Ex If I put As in the grade book at the
beginning of the semester, would you work hard?
35

• 2. Adverse Selection
• expect repeat business
• distorted or concealed information is
• involved
• One party suffers because the other conceals
• information
• Major reason for laws that forbid fraud
• EX you used car is a LEMON

36
Consumer Policy caveat emptor let the buyer
beware caveat venditor let the seller
beware More of caveat venditor through govt
edicts that prohibit or mandate