Chapter 3: Theory of Consumer Behavior or Choice

Consumer is one who demands for products and services.

As one who chooses, desires, and purchases the goods, consumers have
the power or the command to dictate what is to be produced in the market.
Such power is known as consumer sovereignty. As demand comes from
consumers, an increase in demand generally results to increase in supply as
consumer’s choice bring more profit to sellers.

Anything that satisfies needs, wants and desires of consumers in

exchange for something with value are known as goods. There are several
classifications of goods depending upon their characterization in relation to
consumers.

In economics, there are two basic types of goods: tangible economic

products or simply products, which are all physical and concrete goods bought
by consumers to satisfy their longings, and intangible economic activities or
simply known as services, which are all undertakings and pursuits that fulfills
the consumers in exchange for money or other things with value.

The other classifications of goods are as follows:

1. Consumer Goods- these are goods that directly satisfy consumers. The
three important characteristics should be present in order for a good to
be considered as consumer goods: 1. Yields direct satisfaction, 2. easily
found in the market. 3. Bought to instantly satisfy consumers.
2. Essential/ Necessity Goods- these are goods that satisfy the needs of
consumers. These are good which people cannot survive without.
3. Luxury Goods- these are goods that people can live without but are
bought for pleasure, comfort, and well-being.
4. Economic Goods- these are goods which are both useful and scarce.
5. Free Goods- these are goods so abundant that everyone can be satisfied
without necessarily paying anything during the consumption.

There are also instances when people pay for things yet they receive or
experience frustration or dissatisfaction or disappointment. Such are not
called goods but rather known as bads.

Consumers will always choose goods over bads. Moreover, the behavior
of the consumers shape the flow of the market of goods as to what will be
produced and what will be obsolete in time depending on how much
satisfaction they gain from the use of the different goods offered in the market.
Also, the behaviors of the consumers depend on different scenarios and
constraints.

Utility
 It is assumed that consumption of any goods whether products or
services give satisfaction to consumers. In the field of economics, pleasure or
satisfaction is measurable. As customers consume bundle or combination of
products and services, they receive happiness or fulfilment and such is
measured by utility. The unit of measurement for utility is called utils. Utils
will be measured through the concept of marginal utility which is the amount
of additional satisfaction obtained by consumers for every additional unit of
goods consumed. In addition, the sum of all marginal utility or long run
satisfaction is known as total utility.

The marginal utility of any good is the increase in the utility that the
consumer gets from an added unit consumed of that certain good. Generally,
the goods consumed display diminishing marginal utility. The concept
suggests that: the more goods the consumer gets, the marginal utility provided
by an extra unit of such good becomes lower.

For economists and analysts, they have observed that consumers prefer
a certain bundle of goods versus another when the first chosen bundle provides
more utility than the rest of the other bundles revealing the concept of cardinal
utility or assigning numerical value for preferences. Ranking the utility of
goods as to first, second, third and succeeding preference is known as the
concept of ordinal utility.

Example:

Assume that Juan gets 10 utils after eating 10 pcs of fish balls and 5 utils after
eating the same number of squid balls. Then, he gets 8 utils after eating 10
more fish balls.

In the given scenario.

 -Cardinal utility explains that Juan was able to gain 5 utils for 10
pieces of squid balls, 10 utils and 8 utils for the two sets of 10 pieces of
fish balls respectively.
 -Ordinal utility clarifies that Juan prefers fish balls over squid balls as
he was able to get more satisfaction from the former.
 -Total utility summarizes that Juan was able to have 18 utils for the
consumption of fish balls.
 -Marginal utility simplifies that from the first set of fish balls and the
second set of fish balls, Juan’s marginal utility for the second set of fish
balls is 2.

The formula for the total utility:

Tu= Mu1 + Mu2 + Mu3………..

The formula for marginal utility:

Mu= Change in Tu/ Change in Q

Or Mu= (Tu2-Tu1) / (Q2-Q1)

Budget Constraint

Everyone would want to have all his/her desires yet there will always be
bounds on up to what extent one will be able to acquire. One of which is
budget constraint. Budget constraint is the limit on the consumption bundles
that a consumer can afford. People spend less than what they desire because
their spending is limited or constrained by their income.

Example:

Assume that there are only two goods in the market: Tangible economic
products and Intangible economic services.

Suppose a person has:

A budget of P1000.00

A unit of product is worth P100.00

A unit of service is worth P200.00

Note: For ease in understanding budget constraint, it is better to create a

budget constraint table and a budget constrain curve.

Unit/s of Unit/s of Spending on Spending on Total

Product Service Product Service Spending
0 5 P0 P 1000 P 1000
2 4 200 800 P 1000
4 3 400 600 P 1000
6 2 600 400 P 1000
8 1 800 200 P 1000
10 0 1000 0 P 1000
Note:

Optimum Bundle is the combination of goods that gives the maximum

satisfaction to consumers that is within the bounds of their budget.

Inefficient Bundle is the combination of goods which does not provide

maximum satisfaction to as the budget of the consumers has not yet been
maximized.

Infeasible Bundle is the combination of goods which does not provide

satisfaction at all because the bundle is beyond the budget that the consumer
can afford.
There are Four Factors that can affect consumption in relation to Budget
Constraint. These are:

1. Income- An increase in income increases the budget that can be used for
purchase, thus a shift in the budget constraint line to the right, thereby
exhibiting increase in the bundles that the consumer can choose from. A
decrease in income leads to decrease in budget shifts the budget
constraint line to the left, shrinking the possible bundles that can
provide optimum satisfaction to consumers.
2. Supply of Goods- An increase in the supply of goods does not affect the
budget rather adds to the options of bundles that the consumer can
choose from. A decrease in supply also does not affect the budget but it
decreases the choices of combination of goods that the consumer can
purchase.
3. Price of Goods- An increase in the price of goods in effect decreases the
budget as the consumer will be bounded by tighter constraint, therefore,
shifting the budget constraint line to the left. A decrease in the price of
goods in effect increases the bundle of goods that the consumer can
afford, thus, shifting the budget constraint line to the right.
4. Savings- An increase in savings decreases the available budget to be
used for consumption, thus, shifting the budget constraint line to the
left. A decrease in money to be kept for savings allows the consumers to
have increase in budget, thus, gaining more bundles for consumption to
consumers.

Indifference Curve

Indifference is the feeling of unconcern or disinterest in things.

Consumers come to the point where in the combination of goods may have
varying bundles yet can provide the same level of satisfaction. Indifference
Curve shows the different consumption bundles that give the consumers same
level of satisfaction.

The consumer’s preferences are depicted by indifference curves which

display the combinations of French fries and chicken nuggets that provide
same or equal level of satisfaction for consumers. Marginal rate of
substitution displays the willingness of consumers to trade one good for
another. In the given example, MRS is the rate tolerable to consumer to change
from point A to point B to achieve the same level of satisfaction.

Notes:

a. Higher indifference curves are favored than lower indifference curves.

Consumers want more than they will opt for less. Higher indifference
curves provide greater amounts than lower indifference curves as seen
on the indifference curves.
 b. Indifference curves do not intersect. When there is a decrease in the
consumption of one good it is imperative that the consumption of the
other goods is increased. Thus, there will never be a situation where
there is a point in the lower indifference curve crossing the higher
indifference curve or vice versa as they are aligned and draw in parallel
to each other displaying increase or decrease in bundles of different
amounts and levels.
c. Indifference curve is bowed inward and is downward sloping. For the
consumers to be equally satisfied yet following the marginal rate of
substitution, a consumer is more willing to have a good in abundance to
be taken away in exchange for the good with less goods with limited
supply. The downward slope displays the rate of substitution and the
inward bow of the curve displays the willingness to trade goods in
abundance.

When a good is easy to substitute, it is less bowed inward. While when a

good is hard to substitute, it is very bowed inward.

Special Cases on Indifference Curves

There are two types of indifference curves which are in straight lines: a.
Perfect substitutes are two goods with straight-line indifference curves. B.
Perfect complements are two goods with right-angle indifference curves.