Consumer Behavior Theory
In this Chapter, we will look closer at the behavior of individual Consumers. The Consumer Behavior theory is where the law of demand is Derived.
There are two approaches in explaining the consumer Behavior:
- The Utility Approach
- The Budget Line and Indifference curve analyses
The Utility Approach
Humans have insatiable needs and wants which are not always fulfilled because of the scarcity of resources. For this reason, whenever a consumer’s needs or wants are met, he/she positively achieves a degree of happiness and satisfaction. In economics, this is called Utility.
Since there is no exact measurement of this value, economists rate utility in Utils in a scale from 0-10, meaning the least useful or satisfying and 10 means the most useful or satisfying.
The Law of Diminishing Marginal Utility
The Law Of Diminishing Marginal Utility states that all else equal as consumption increases the marginal utility derived from each additional unit declines. Marginal utility is derived as the change in utility as an additional unit is consumed. Marginal utility is the incremental increase in utility that results from consumption of one additional unit. In addition, as a consumer uses up a good or a service, He/She tends to get less and less satisfied with it through time. The greatest satisfaction is experienced by consuming the first quantity of the said good.
Two Utility Concept
Total Utility is the overall happiness derived by a consumer with regard to his consumption of a product.
Marginal Utility refers to the amount of additional utility received in every consumption of an additional units of goods.
A student spent his allowance in Playing Defense Of The Ancients (DOTA). The Figure in 4.1 shows the Total and Marginal Utility for Playing DOTA.
In the graphical illustration of the students Total Utility in Playing DOTA in Figure 4.2. We can observe that there is an increasing slope of utility up to the 6th hour and upon reaching the 6th hour of playing, the utility was maximized, then a diminishing slope occurred after the 7th hour of playing.
as observed in Figure 4.3, the marginal Utility continuously declined.
Marginal Utility is equal to the change of the Total Utility.
The Budget Line and Indifference Curve
In this approach, we assume that consumer is capable of consuming any amount of goods he/she so desires, but in reality, we are constrained by limited resources, which include the limited means to buy a product at a given price.
The consumers’ power to purchase and consume goods and services are subject to their means, Hence, in studying consumer behavior, we also need to consider the buyer’s limited income and the price of a particular good or service. At this point, the utility maximization rule does not center only on the amount of satisfaction a consumer gets but also on the ability to consume more and get satisfied with spending less.
The Budget Line is a graphical representation pf the amount of goods a consumer can afford. Affordability, as we know it depends on the good’s price and the buyer’s income. For this reason, we can assume that in a budget line, the amount of total units of goods spent should not exceed the income of a consumer.
We can in the figure above that in point (0,10) the consumers whole budget was spent only on product Y while in point (10,0), all the budget was spent to product X.
The Indifference Curve is a line illustrating a consumer’s responsiveness or indifference based on a combination of two products (X and Y). It also shows an infinite combination of X and Y, which gives the same level of satisfaction.
We can see in the above figure that the consumer at point (20,80) Prefers good Y and at point (80,15) favors product X.
Optimum Combination and the Marginal Rate of Substitution
If we combined the budget line and the indifference curve in Figure 4.6, the optimum combination is highest indifference curve that touches the budget line at a point of tangency.
Tiffany has a shopping budget of Php 8,000.00, She shop at MAC and saw 2 Items that she wanted to buy and spent all here money on. what is the best combination to satisfy her wants?
to compute for the Marginal Rate of Substitution the equation is as follows:
therefore applying the equation to our example: