consumer behavior

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Managerial Economics: BUS 525-2 Lecture 3 Dr. Ahsanuzzaman Department of Economics North South University, Dhaka, Bangladesh Email: [email protected] ; [email protected] February 14, 2015 Managerial Economics: BUS 525-2

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Consumer Behavior

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  • Managerial Economics: BUS 525-2Lecture 3

    Dr. AhsanuzzamanDepartment of Economics

    North South University, Dhaka, BangladeshEmail: [email protected]; [email protected]

    February 14, 2015

    Managerial Economics: BUS 525-2

  • Consumer Behavior

    Theory of consumer behavior: Description of how consumersallocate incomes among different goods and services tomaximize their well-being.Steps to understand consumer behavior

    1 Consumer Preferences: The first step is to find apractical way to describe the reasons people might preferone good to another. Presentation of consumers preferences for variousgoods described graphically and algebraically.

    2 Budget Constraints: Consider price and limited income. Combine Consumer preferences and budget constraintstogether.

    3 Consumer Choices: Given preferences and budgetconstraints, consumers choose to buy combinations ofgoods that maximize their satisfaction.

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    Assumption: Consumers make purchasing decisions rationally(really?)Consumer PreferencesMarket Baskets/Bundles: List with specific quantities of oneor more goods.

    The theory of consumer behavior explains whether to preferone market basket to another.

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    Basic Assumptions about Preferences

    1 Completeness: Preferences are assumed to be complete Consumers can compare and rank all possible baskets. for any two baskets A and B, consumer prefers either Ato B or prefers B to A, is indifferent between the two.Indifferent the person will be equally satisfied with eitherbasket

    2 Transitivity: Preferences are transitive (consistent).Baskets A,B, and C...

    3 More is better than less Locally non-satiated.

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    Indifference Curves (IC)An IC represents all combinations of market baskets thatprovide a consumer with the same level of satisfaction.

    Figure: Describing Individual PreferencesManagerial Economics: BUS 525-2

  • Consumer Preferences

    Indifference Curves (IC)

    Figure: An Indifference Curve

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    Indifference Maps (IC): Graph containing a set of indifferencecurves showing the market baskets among which a consumeris indifferent

    Figure: Indifference maps

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    The Shapes of ICs:The Marginal Rate of Substitution:

    Figure: The MRSManagerial Economics: BUS 525-2

  • Consumer Preferences

    Convexity: The MRS falls as we move down the IC gives ashape which is convex to the origin and is termed as convexpreference".This provides an additional assumption about the preference:Diminishing Marginal Rate of Substitution:

    Figure: The MRS

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    Perfect Substitutes and Perfect Complements:

    Figure: Perfect Complements and Perfect SubstitutesManagerial Economics: BUS 525-2

  • Consumer Preferences

    BIG QUESTION:

    What will be the IC of bads????

    Managerial Economics: BUS 525-2

  • Consumer Preferences

    Utility: Numerical score representing the satisfaction that aconsumer gets from a given market basketUtility Functions: Formula that assigns a level of utility toindividual market baskets. Example: U(F ,C) = F + 2C. Or forthe figure below: U(F ,C) = FC

    Figure: Utility Functions and Indifference CurvesManagerial Economics: BUS 525-2

  • Consumer Preferences

    Ordinal Utility Function: Utility function that generates aranking of market baskets in order of most to least preferredCardinal Utility Function: Utility function describing by howmuch one market basket is preferred to other

    Managerial Economics: BUS 525-2

  • Budget Constraints

    Budget constraints: Constraints that consumers face as aresult of limited incomes The Budget Line: All combinations ofgoods for which the total amount of money spent is equal toincome

    Figure: Mkt basket and thebudget line Figure: A budget line

    Managerial Economics: BUS 525-2