consumer behavior and demand chapter 3. characteristics of consumer behavior human wants are...

Consumer Behavior and Demand

Chapter 3

Characteristics of Consumer Behavior

Human wants are insatiable More is preferred to less

Utility

Utility is defined as the amount of satisfaction received from a good or bundle of goods.

Cardinal measures of utility Numbers provide a measure of how much

more you like one good over another Ordinal measure of utility

Numbers provide a measure preference ranking

Cardinal versus Ordinal measures

Law of Diminishing Marginal Utility

As a person consumes additional units of a product, they derive less satisfaction from each additional unit.

Marginal Utility is equal to the additional utility derived from consuming one more unit of a good.

Utility from Pizza

Pizza Slices Total Utility Marginal Utility

1 2 3 4 5 6

5 9 12 14 15 15

Utility from Pizza


123456

59

12141515

5

Utility from Pizza


123456

59

12141515

54

Utility from Pizza


123456

59

12141515

543210

4x4 Trucks Total Utility Marginal Utility

1234

500850

10751175

500350225100

Utility from Trucks

Let’s throw in a John Deere tractor


1234

One big greenmachine

500850

107511751175

500350225100

0

Now let’s try that Kubota


1 2 3 4

One big orange machine

500 850

1075 1175

200,000,000

500 350 225 100

199,999,825

Wow, would you look at that!

Choices in Consumption Let’s move from one good to two now

Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

. This dot represents a consumption bundle for the consumer

In math it is an ordered pair and can be calculated like this (# Cokes, # Pizzas)

Choices in Consumption

Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

. This dot represents a consumption bundle for the consumer

In math it is an ordered pair and can be calculated like this (# Cokes, # Pizzas)

Therefore this bundle of goods is made upof one coke and seven pizza slices

(1,7)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

.

.. .

.Several Ordered Pairs = (# Cokes, # Pizzas)

These represent different consumption bundles for the consumer


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

.

.. .

.(1,7)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

.

.. .

.(1,7)

(2,5)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

.

.. .

.(1,7)

(2,5)

(10,1)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

.

.. .

.(1,7)

(2,5)

(10,1)

(6,2)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

.

.. .

.(1,7)

(2,5)

(10,1)

(6,2)

(3,3)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

This line is called an indifference curve

It can be labeled I or U for Utility Curve

I


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Every point on an indifference curve givesthe consumer the same level of utility or satisfaction


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are:Continuous


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are:Continuous

This one is not continuous


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are:ContinuousConvex to the origin


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are:ContinuousConvex to the origin

This is not convex to the origin


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are:ContinuousConvex to the originFill the plane and never cross


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are:ContinuousConvex to the originFill the plane and never cross

These cross and just make a mess.


Why can’t they cross?

Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

The farther the indifference curve is awayfrom the origin the better off the consumer is. The more of each good they have:-)


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Better Off

Worse Off


Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Indifference curves are convex to the originthis gives us the Law of Diminishing Marginal Rate of Substitution

What is means is that we are willing to give up fewer and fewer slices of pizza to get an additional coke



Pizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Remember I said we are constrained, in otherwords we can’t get everything we want. How is that represented on this graph?

Choices in ConsumptionPizza Slices

Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Let’s say we have $10 to spend a day onpizza and coke, what does that constraint look like?

Well we need to know a couple other thingslike what are the prices of coke and pizza.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

If the price of pizza is $2 a slice how manycan we afford if we spend all our money income on pizza?


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

If the price of pizza is $2 a slice how manycan we afford if we spend all our money income on pizza? The answer is 5 slices..


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

If the price of coke is $1 a glass how manycan we afford if we spend all our money income on coke?


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

If the price of coke is $1 a glass how manycan we afford if we spend all our money income on coke? The answer is 10 cokes.

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

These are the two endpoints of what is known as a budget constraint. You can afford to purchase one or the other.

.

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

The budget constraint shows every possiblecombination of goods that the consumer can purchase with a certain money income.In this case it’s $10

.

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

How do we answer the question of how consumers choose how much of each to consume? Remember what a utility curve represents?

.

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Which point do you think the consumer willchoose A, B or C? Why did you choose thatpoint?

.

.A

B

C

..

. I1I2


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

What happens to the budget constraintwhen the price of a good changes?

BC


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

If the Price of Coke doubles to $2.00 the budget constraint moves. More specifically it rotates clockwise with the Pizza slice endpoint staying the same.It rotates until the coke endpoint is on 5.

BC


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

This is because we can only afford 5cokes if when spend all of our income on coke now.

BC1BC2


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

What happens in a case where the pricesof both pizza and coke double?

BC


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

What happens in a case where the pricesof both pizza and coke double? The new budget constraint shifts inward with the endpoints 2.5 pizza slices and 5 cokes. Itis a parallel shift.

BC1BC2


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

How does our consumption change now?

BC1BC2


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

How does our consumption change now?

BC1BC2

A.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

How does our consumption change now? We move from point A to Point B.

BC1BC2

A

.B

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Now lets go back to the example where theprice of coke goes from $1 to $2. How doesthat affect consumption?

BC1


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1


BC1BC2


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1


BC1BC2

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1


BC1BC2

..


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1


BC1BC2

.


Substitution Effect - when the price of a good changesrelative to another good, we substitute consumption towardsthe good that has become relatively less expensive.

Income Effect - When the price of a good decreases the consumers real income has risen, thus creating the potentialfor consumption of both goods to increase.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Now lets see how we can use this utility analysis to map out a demand curve for this consumer

BC1

.We start here with the price of coke at $1. When the price is $1 the consumerbuys 5 cokes and 2.5 slices of pizza.


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Now lets have the price of coke increasingfrom $1 to $2. How does that affect consumption?

BC1BC2

..


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Coke consumption goes from 5 units down to 3 units. The price goes up, consumption goes down. (Follows theLaw of Demand)

BC1BC2

..


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Now lets map out this consumer’s demandcurve.

BC1BC2

..


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1

Now lets map out this consumer’s demandcurve.

BC1BC2

..How many cokes will this consumer buyat a price of $1……. 5 Cokes

Choices in ConsumptionPrice Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)


Coke1 2 3 4 5 6 7 8 9 10 11 12

7

6

5

4

3

2

1BC1BC2

..How many cokes will this consumer buyat a price of $2……. 3 Cokes


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)

. (3, $2.00)


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)

. (3, $2.00)

Demand Curve for Coke


Now we need to be able to determine the market demand curve for a product like this coke for an individual.


Now we need to be able to determine the market demand curve for a product like this coke for an individual.

The market demand curve is the horizontal summation ofall individual demand curves for that particular good.


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)

. (3, $2.00)

Jane’s Demand Curve for Coke


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)

.(2, $1.50)

Bill’s Demand Curve for Coke


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)

.(2, $1.50)


. (5, $1.00)

. (3, $2.00)



Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

. (5, $1.00)

.(2, $1.50)


. (5, $1.00)

. (3, $2.00)


. (4, $1.50)


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50

(6, $1.50)

(10, $1.00)

. (3, $2.00)

Market Demand Curve for Coke

..

Types of Demand

Types of Demand

Elastic Demand - When the quantity responseis relatively large compared to the price change.

Types of Demand


Price Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Elastic Demand

Types of Demand


Price Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Elastic Demand

If you lower price total revenue increases

Types of Demand

How is total revenue calculated?

Types of Demand

How is total revenue calculated?

It is the price of the product times the quantity sold

Types of DemandPrice Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Elastic Demand

.Total

Revenue =$8

When Price = $2


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Elastic Demand

.Total

Revenue =$12

When Price = $1

Types of Demand

Inelastic Demand - When the quantity responseis relatively small compared to the price change.

Types of Demand


Price Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50 Inelastic Demand

Types of Demand


Price Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00


If you lower price total revenue decreases

Types of Demand

Remember total revenue is calculated by the price of the product times the quantity sold


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00


Total Revenue

=$6

When Price = $3.


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00


TotalRevenue =

$5

When Price = $1

.

Types of Demand

Elasticity of Demand is considered to be Unitary when thePercentage changes in price and quantity demanded are the same.

In this case an increase in price doesn’t change the levelof income.

Types of Demand

How do you calculate the Elasticity of Demand?

Price Elasticity of Demand =

%Change in Quantity

% Change in Price

Types of Demand

How do you calculate the Elasticity of Demand?

Price Elasticity of Demand =

Q2 - Q1

P2 - P1

Q2 + Q1

P2 + P1

Price Elasticity of Demand

Ed > 1, Elastic Ed < 1, Inelastic Ed = 1, Unitary Elastic

One important note is that all of these elasticities are negative, So we just take the absolute value of them. The sign for a Price elasticity is meaningless.

Factors That Influence DemandElasticities

How many close substitutes there are for the product

Whether or not there are many alternative uses for the product

Whether the product is a major expenditure in the consumers budget

Factors That Influence DemandElasticities

What is the difference between a Change in Quantity Demanded and a Change in Demand?

A change in Quantity DemandedPrice Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50 Demand for Coke

.


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50 Demand for Coke

.

. Price goes up from $1 to $3 and the Quantity Demanded goes down from5 cokes to 2.


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50 Demand for Coke

.

.Notice the demand curve did not change, However the consumer’s position on that Demand curve did change.


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50 Demand for Coke

.

.A change in Quantity Demanded impliesA movement along the demand curve.

A price increase implies that QuantityDemanded decreases.

A Change in DemandPrice Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Coke

.A change in Demand impliesA movement of the the demand curve.


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Coke

.A change in Demand impliesA movement of the the demand curve.

New Demand for Coke


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50 Demand for Coke

..A change in Demand impliesA movement of the the demand curve.

Now at $3 the consumer demands4.5 units instead of the initial 2.

New Demand for Coke


Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Coke

..A change in Demand impliesA movement of the the demand curve.

Now at $3 the consumer demands4.5 units instead of the initial 2.

Demand is said to have risenFor this product.

New Demand for Coke

What Creates Changes in Demand?

Population Income Tastes and Preferences Related Product Prices People’s Expectations

A Change in Demand from Population

Price Coke $

Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Coke

An increase in Population shifts the demand curve outward.

New Demand for Coke

A Change in Demand from Income

Price Steak $

Steak1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Steak

An increase in Income shifts the demand curve for Steak to the right

New Demand for Steak

A Change in Demand from Income

Price Spam $

Spam1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Spam

An increase in Income shifts the demand curve for Spam or Riceto the left

New Demand for Spam

A Change in Demand from a Change in Tastes and Preferences

Price HealthFood $

Q Health Food1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Health Food

An increase in Health Concerns shifts the demand curve for Health Food to the right

New Demand for Health Food

A Change in Demand from a Change in the price of a Related Good

Price Coke $

Q Coke1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Coke

An increase in the price of Pepsi shifts the demand curve for Coke to the right

New Demand for Coke

They are Substitutes

A Change in Demand from a Change in the price of a Related Good

Price Hamburgers $

Q Hamburgers1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Hamburgers

An increase in the price of French Fries shifts the demand curve for Hamburgersto the left

New Demand for Hamburgers

They are Complements

A Change in Demand from a Change in Consumer’s Expectations

Price Gasoline $

Q Gasoline1 2 3 4 5 6 7 8 9 10 11 12

3.50

3.00

2.50

2.00

1.50

1.00

.50Demand for Gasoline

If consumers expect there to be a shortageOn gasoline, then the demand curve forGasoline will shift to the right.

New Demand for Gasoline

Income Elasticities

Income Elasticity =

% Change in Quantity of Product

% Change in Income of Consumer

Income Elasticities

Engel Curve – The relationship between the consumers income and the quantity he or she purchases of an item.

Engel Curve for Food

Quantity Food Purchased

Weekly Income in 000’s

1 2 3 4 5 6 7 8 9 10 11 12

Engel Curve for Clothing

Quantity ClothingPurchased

Weekly Income in 000’s

1 2 3 4 5 6 7 8 9 10 11 12

Income Elasticities

Income Elasticity =

Q2 - Q1

I2 - I1

Q2 + Q1

I2 + I1

Income Elasticities

Ei > 0, Normal Good Ei < 0, Inferior Good

Ei> 1, Luxury Ei< 1, Necessity

Cross Price Elasticities

Cross Price Elasticities measure the responsivenessOf Demand for good 1 to a change in the price of good 2

Answers the question: How does the quantity demanded of coke Change from a change in the price of pepsi?


For Substitutes: An increase in the price of one Will increase the demand of the other.

The Cross Elasticity of Coke for Pepsi is > 0

Ec,p>0

Coke and Pepsi


For Complements: An increase in the price of one will decrease the demand of the other.

The Cross Elasticity of Hamburgers for French Fries is < 0

Eh,ff <0

Hamburgers and French Fries

consumer behavior and demand chapter 3. characteristics of consumer behavior human wants are...

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