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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
4
5
6
7
0
10
18
24
28
30
30
28
10
8
6
4
2
0
-2
Total Utility
TU(1)Tacos
ConsumedPer Meal
MU
]]]]]]]
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