Consumer Behaviour (water-diamond Theory) 204d4n

CHAPTER 4: CONSUMER BEHAVIOR THEORY Presented by: Bautista, Aaron Benedict Gales, Benedict Troy Mata, Mark Stephen

INTRODUCTION •

In the previous lessons, it was said that there are non-price factors that can affect both consumers’ propensity to buy and producers’ propensity to sell products.

•

The Consumer’s Behavior Theory is where the law of demand is derived. This is because the consumers are the ones interested in buying and consuming products.

There are two approaches in explaining consumer behavior:

Utility The

Approach

Budget line and Indifference curve analyses

THE UTILITY APPROACH • Whenever

a consumer’s needs or wants are met, he/she positively achieves a degree of happiness and satisfaction. In economics, this want-satisfying ability is called utility.

• In

economics, economists rate utility in utils in a scale from 0–10, 0 meaning the least useful or satisfying and 10 meaning the most useful or satisfying.

THE LAW OF DIMINISHING MARGINAL UTILITY •

In consumer behavior theory, it is expected that every buyer’s choice revolves around a utility-maximization rule, that is, a consumer buys the product that can provide him/her with the highest level of satisfaction or utility. Consequently, whenever the consumer is faced with a selection of alternatives, he/she will always choose the product that will give him/her more pleasure.

• The

law of diminishing marginal utility is the one of the by-products of the consumer behavior theory. This law states that a consumer 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 concepts of under the Law of Diminishing Marginal Utility:

• 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

Total and Marginal Utility for Siomai

Quantity 1 2 3 4 5 6 7

TU 10 19 26 30 30 26 19

MU --9 7 4 0 -4 -7

Observations from the table •

Marginal unity is the change in total utility as we consume an additional unit of product. Total utility, therefore, changes relative to the changes in marginal utility.  

•

Total utility, in general, increases as more and more units of the product are consumed. However, at some point, when the marginal utility is less than 0, total utility decreases.

•

Marginal utility diminishes as the consumption of the same good becomes higher (Law of Diminishing Marginal Utility).

Summary of Utility  

MU

TU

Phase I

diminishi Increasin ng g Phase II Zero Maximum Phase III Negative diminishi ng

THE BUDGET LINE AND INDIFFERENCE CURVE • In

this approach we assume that a consumer is capable of consuming any amount of goods he/she so desires.

• In

reality, we are constrained by limited resources, which include the limited mean 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.

• 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 while spending less.

• The

budget line is a graphical representation of the amount of goods a consumer can afford.

• Affordability

depends on the good’s price and the buyer’s income.

• With

this, we can assume that in a budget line, the amount of total units of goods spent should not exceed the income of a consumer.

• 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.

OPTIMUM COMBINATION AND THE MARGINAL RATE OF SUBSTITUTION • The

optimum combination is the highest indifference curve that touches the budget line at a point of tangency.

• The

optimum level, a consumer is able to buy the maximum amount of two goods given a specific budget.

Budget Schedule for Goods X and Y Points Good X Good Y A 8 0 B 7 1 C 6 2 D 5 3 E 4 4 F 3 5 G 2 6 H 1 7 I 0 8

Indifference Schedule for Goods X and Y Points J K L M N

Good X 8 6 4 3 2

Good Y 2 3 4 6 8

 

EQUIMARGINAL PRINCIPLE •

The equimarginal principle states that a consumer will get maximum satisfaction from goods X and Y when the MU of the last Peso spent on good X is exactly the same as the MU of the last peso spent on good Y, income being fixed.  

INCOME EFFECT AND SUBSTITUTION EFFECT • An

income effect happens when the budget line shifted to the right brought about by an increase in the consumer’s budget or from a decrease in the prices of goods X and Y.

• The

substitution effect or the pivotal movement of the budget line happens if there is a decrease in its price and there is no change in the price of the good Y. The budget line is still the same, but consumer’s choice is now biased toward the good with the lower price, in this case good X.

PARADOX OF VALUE • Adam

Smith, an English economist, presented the Water-Diamond Theory or Paradox of Value which states that consumers are willing to give up zero or little money to get certain products that give them significant total benefit.

• One

refers to value in exchange, as in the case of diamonds, which is based on its scarcity. The second type refers to value in use, as in the case of water, which is based on its importance.

• Both

of them have “value”. Water has more value in use and less or little value in exchange, and diamonds has more value in exchange and less or little value in use.

QUESTIONS

1. What happens if your allowance increases from PHP 150/day to PHP 250/day. Would you change your taste and preference, or would you stick with your old consumption patterns?

2. Why do some people buy expensive branded things even if they cannot afford them?

3. Can we apply the law of diminishing marginal utility to money? Explain you answer.

4. What is the advantage of the equimarginal approach?

5. What is the importance of the water-diamond theory?

6. Why do some people perceive inexpensive goods to be less

7. Give some examples of “free goods.” Do they give you satisfaction? Explain your answers.