Consumer Behaviour

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How Consumers Make Choices

What is Consumer Utility?

• In economics, utility is a measure of happiness or satisfaction.
• Consumers are assumed to be rational people who will try to maximize his/her utility.

Marginal Utility

• Utility that a consumer derives from consuming one more of the same consumer good that he or she is consuming during a given consumption period.

Total Utility

• Total utility a consumer derives from the consumption of all units of a good in a given consumption period.

The Law of Diminishing Marginal Utility

• Over a given consumption period, the more of a consumption good that is consumed by a consumer, the less marginal utility an additional unit contributes to the total utility
• For example, on a very hot day, after doing her morning run, Helen is very thirsty. At this particular moment, drinking a bottle of coke will really cool her down and increase her utility. However, after drinking 5 more bottles Helen no longer feels thirsty and actually feel very full. Now drinking an additional bottle of coke will not increase her total utility. In other words, her marginal utility of additional units begins to fall.

Maximizing Utility

• Economists assumes that consumers are rational beings therefore they will seek to maximize their utility. A rational consumer will buy an additional unit of a consumer good as long as their perceived utility is higher than the relative price. In other words, when the utility is below the market price, consumers will no longer want to buy an additional unit of a particular good because the cost of the additional unit outweighs the benefits.
• Utility is therefore maximized when the marginal utility is equal to the price

Consumer Behaviour When Facing Constraints

Indifference curve

• A curve that shows a collection of consumer goods that give the consumer the same level of utility

Budget constraint

• The limit on the consumption bundles that a consumer can afford

Substitution Effect

• The change in consumption that results from a change in the price of a related good.
• Shift occurs along the same indifference curve because the budget constraint stays the same.

Income Effect

• The change in consumption that results from a change in income.
• Shift occurs at a lower indifference curve because the budget constraint is lowered.

Normal good

• A good where when the income increases, the quantity demanded will also increase.

Interior good

• A good where when the income increases, the quantity demanded will decrease.

Giffen good

• A good for which an increase in the price raises the quantity demanded.