Consumer Behavior Theory - Notes

Consumer Behavior Theory

Consumer Behavior Theory 

A set of theories explaining how consumers behave so that producers can make their production decisions accordingly  Utility

Theory (Theory of the Consumer): assumes that preferences and choices of consumers are determined independently of income and prices  Indifference Theory: assumes that when given a choice between two goods, a consumer is indifferent to the combination of goods, as long as the goods are in their basket; use of budget

Utility Theory Utility – satisfaction; usefulness  Total Utility (TU) – total satisfaction derived from consumption  Marginal Utility (MU) – the change in total utility derived from a unit change in consumption of a good 

Graph the Following: No. of Servings Satisfaction/ Serving (MU)

Total Satisfaction (TU) 10

1

10

2

9

19

3

8

27

4

7

36

5

6

42

Utility TU

MU

No. of servings

Law of Diminishing Marginal Utility 



As more of a good is consumed per period, the marginal utility (MU) derived from consuming one more unit of that good decreases The more of a good consumed per period, the smaller the increase in total utility (TU) from consuming one more unit of that good, ceteris paribus

> Basis for the Law of Demand

Utility Theory Conditions  

Without scarcity With scarcity: how will a consumer behave in terms of consumption given certain constraints (e.g. availability of resources, prices, money/income available, substitutes available)

> Utility Theory is not very useful under scarcity conditions, but does provide an insight into how a consumer behaves over a period of time

The Equi-Marginal Principle  



Every rational consumer wants to maximize the amount of satisfaction they can obtain given a fixed income. Basically, the consumer faces two limitations in their quest for maximum satisfaction: their income and the price of the good they prefer. The Equi-Marginal Principle states that the consumer achieves maximum satisfaction when the marginal utility per peso spent on a particular good is equal to the marginal utility per peso spent on any other good: MUA _____ = PA

MUB _____ PB

Example: Given Budget of P70.00 Good A = P20.00

Good B = P10.00

Q

MU

MU/P

Q

MU

MU/P

1

500

25

1

300

30

2

400

20

2

250

25

3

300

15

3

200

20

4

230

11.5

4

150

15

5

160

8

5

100

10

What Combinations? 

What combinations of Good A and Good B would maximize the consumer’s utility? 

1A, 2B  2A, 3B  3A, 4B

 What combinations of Good A and Good B

would maximize both the consumer’s utility and budget? 

1 (P20) + 2 (P10) = P 40.00  2 (P20) + 3 (P10) = P 70.00  3 (P20) + 4 (P10) = P100.00  FINAL ANSWER: 2A, 3B

Exercise 

The following table illustrates Bob’s utilities from watching first-run movies in a theater, and from renting movies from a video store. Suppose that he has a monthly entertainment budget of P600, and each movie in a theater costs P100 while each video rental costs P50. A. What are the combinations of movies in a theater and movies from a video store that Bob should consider to fully maximize his utility? B. What is the combination of movies in a theater and movies from a video store that would maximize Bob’s utility and budget? Prove by showing the computation.

Movies in a Theater Q

TU

0

MU

Movies from a Video Store MU/P

Q

TU

0

0

0

1

200

1

220

2

260

2

265

3

310

3

305

4

350

4

340

5

380

5

370

6

400

6

395

MU

MU/P