Study Guide For Module No. - : Consumer Behavior

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STUDY GUIDE FOR MODULE NO. ___ 3

CONSUMER BEHAVIOR

MODULE OVERVIEW

This module explains the principles underlying consumer demand. We will see how
consumers make consumption decisions, how their preferences and budget constraints determine
their demands for various goods, and why different goods have different demand characteristics.

How can a consumer with a limited income decide which goods and services to buy? This is a
fundamental issue in microeconomics—one that we address in this module and the next. We will
see how consumers allocate their incomes across goods and explain how these allocation decisions
determine the demands for various goods and services. In turn, understanding consumer
purchasing decisions will help us to understand how changes in income and prices affect the
demand for goods and services and why the demand for some products is more sensitive than
others to changes in prices and income.

MODULE LEARNING OBJECTIVES

At the end of this module, the learners would be able to determine the meaning of consumer
behavior; understand the elements of consumer theory; analyze the properties that are common to
many indifference curves; discuss the role of the budget set and indifference curve in determining
the choice that gives a consumer maximum satisfaction.; and construct the demand curve using
changes in consumption due to price changes.

LEARNING CONTENTS (CONSUMER BEHAVIOR)

Consumer Behavior

Consumer behavior is the actions and the decision processes of people who purchase
goods and services for personal consumption” – according to Engel, Blackwell, and Mansard,
Consumer buying behavior refers to the study of customers and how they behave while
deciding to buy a product that satisfies their needs. It is a study of the actions of the consumers that
drive them to buy and use certain products.
Study of consumer buying behavior is most important for marketers as they can understand
the expectation of the consumers. It helps to understand what makes a consumer to buy a product.
It is important to assess the kind of products liked by consumers so that they can release it to the
market. Marketers can understand the likes and dislikes of consumers and design their marketing
efforts based on the findings.
Consumer buying behavior studies about the various situations such as what do consumers
buy, why do they buy, when do they buy, how often do consumers buy, for what reason do they
buy, and much more.(https://clootrack.com/knowledge_base/what-is-consumer-behavior/)

Consumer behavior is best understood in three distinct steps:

1. Consumer Preferences: The first step is to find a practical way to describe the reasons
people might prefer one good to another.
Consumer preference is defined as the subjective tastes of individual consumers,
measured by their satisfaction with those items after they’ve purchased them. This satisfaction is

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often referred to as utility. Consumer value can be determined by how consumer utility compares
between different items.( https://bizfluent.com/info-8698883-definition-consumer-preference.html)

2. Budget Constraints: Of course, consumers also consider prices. In Step 2, therefore, we


take into account the fact that consumers have limited incomes which restrict the quantities
of goods they can buy. What does a consumer do in this situation? We find the answer to
this question by putting consumer preferences and budget constraints together in the third
step

The budget constraint is the boundary of the opportunity set—all possible combinations of


consumption that someone can afford given the prices of goods and the individual’s income.
(https://www.khanacademy.org/economics-finance-domain/microeconomics/choices-opp-cost-tutorial/utility-
maximization-with-indifference-curves/a/how-individuals-make-choices-based-on-their-budget-constraint-
cnx#:~:text=The%20budget%20constraint%20is%20the,be%20given%20up%20in%20exchange.)

3. Consumer Choices: Given their preferences and limited incomes, consumers choose to
buy combinations of goods that maximize their satisfaction. These combinations will depend
on the prices of various goods. Thus, understanding consumer choice will help us
understand demand—i.e., how the quantity of a good that consumers choose to purchase
depends on its price.

LEARNING ACTIVITY 1

Use supply and demand curves to illustrate how each of the following events would affect the price
of butter and the quantity of butter bought and sold: (a) an increase in the price of margarine; (b) an
increase in the price of milk; (c) a decrease in average income levels.

What do consumers do?


Before proceeding, we need to be clear about our assumptions regarding consumer
behavior, and whether those assumptions are realistic. It is hard to argue with the proposition that
consumers have preferences among the various goods and services available to them, and that
they face budget constraints which put limits on what they can buy. But we might take issue with the
proposition that consumers decide which combinations of goods and services to buy so as to
maximize their satisfaction. Are consumers as rational and informed as economists often make
them out to be?
We know that consumers do not always make purchasing decisions rationally. Sometimes,
for example, they buy on impulse, ignoring or not fully accounting for their budget constraints (and
going into debt as a result). Sometimes consumers are unsure about their preferences or are
swayed by the consumption decisions of friends and neighbors, or even by changes in mood. And
even if consumers do behave rationally, it may not always be feasible for them to account fully for
the multitude of prices and choices that they face daily.
Economists have recently been developing models of consumer behavior that incorporate
more realistic assumptions about rationality and decision making. This area of research, called
behavioral economics, has drawn heavily from findings in psychology and related fields.At this point
we simply want to make it clear that our basic model of consumer behavior necessarily makes some
simplifying assumptions. But we also want to emphasize that this model has been extremely
successful in explaining much of what we actually observe regarding consumer choice and the
characteristics of consumer demand. As a result, this model is a basic “workhorse” of economics. It
is used widely, not only in economics, but also in related fields such as finance and marketing.

Elements of Consumer Theory


1. Consumer Preferences

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2. Budget Constraints
3. Consumer Choice

Consumer Preferences
Given both the vast number of goods and services that our industrial economy provides for
purchase and the diversity of personal tastes, how can we describe consumer preferences in a
coherent way? Let’s begin by thinking about how a consumer might compare different groups of
items available for purchase. Will one group of items be preferred to another group, or will the
consumer be indifferent between the two groups?

Market Baskets
We use the term market basket to refer to such a group of items. Specifically, a market
basket is a list with specific quantities of one or more goods. A market basket might contain the
various food items in a grocery cart. It might also refer to the quantities of food, clothing, and
housing that a consumer buys each month. Many economists also use the word bundle to mean the
same thing as market basket.
How do consumers select market baskets? How do they decide, for example, how much
food versus clothing to buy each month? Although selections may occasionally be arbitrary, as we
will soon see, consumers usually select market baskets that make them as well off as possible.
To explain the theory of consumer behavior, we will ask whether consumers prefer one
market basket to another. Note that the theory assumes that consumers’ preferences are consistent
and make sense.

Sample Market Basket

Some Basic Assumptions About Preferences


The theory of consumer behavior begins with three basic assumptions about people’s
preferences for one market basket versus another. We believe that these assumptions hold for most
people in most situations.

1. Completeness: Preferences are assumed to be complete. In other words, consumers can


compare and rank all possible baskets. Thus, for any two market baskets A and B, a consumer will
prefer A to B, will prefer B to A, or will be indifferent between the two. By indifferent we mean that a
person will be equally satisfied with either basket. Note that these preferences ignore costs. A
consumer might prefer steak to hamburger but buy hamburger because it is cheaper.

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2. Transitivity: Preferences are transitive. Transitivity means that if a consumer prefers basket A to
basket B and basket B to basket C, then the consumer also prefers A to C. For example, if a Ford is
preferred to a Toyota and a Toyota to a Chevrolet, then a Ford is also preferred to a Chevrolet.
Transitivity is normally regarded as necessary for consumer consistency

3. More is better than less: Goods are assumed to be desirable—i.e., to be good. Consequently,
consumers always prefer more of any good to less. In addition, consumers are never satisfied or
satiated; more is always better, even if just a little better.

4. Diminishing marginal rate of substitution: Indifference curves are usually convex, or bowed
inward. The term convex means that the slope of the indifference curve increases (i.e., becomes
less negative) as we move down along the curve. In other words, an indifference curve is convex if
the MRS(marginal rate of substitution) diminishes along the curve.

The marginal rate of substitution (MRS) is the maximum amount of a good that a consumer is willing
to give up in order to obtain one additional unit of another good.

Is it reasonable to expect indifference curves to be convex? Yes. As more and more of one good is
consumed, we can expect that a consumer will prefer to give up fewer and fewer units of a second
good to get additional units of the first one. As the consumption of food increases, the additional
satisfaction that a consumer gets from still more food will diminish. Thus, he will give up less and
less for example clothing to obtain additional food.

Indifference Curves

Indifference curves trace the combination of goods that would give a consumer a certain level of
utility. The indifference curve itself represents a series of combinations of quantities of goods
(generally two) that a consumer would be indifferent between, or would value each of them equally
in regards to overall utility. Indifference curves allow economists to predict consumer purchasing
behaviors based upon utility maximization for a bundle of goods within the context of a given
consumer’s budget constraints and preferences.

The concept of an indifference curve is predicated on the idea that a given consumer has rational
preferences in regard to the purchase of groupings of goods, with a series of key properties that
define the process of mapping these curves.
Indifference curves are always negatively sloped. This is based on the assumption that a consumer
is always better off consuming more of a good, so as quantity consumed of one good increases,
total satisfaction would increase if not offset by a decrease in the quantity consumed of another
good. This also assumes that the marginal rate of substitution is always positive.
Let us take a look at the sample indifference curve below.

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Figure 1. Indifference Curve

The indifference curve U1 that passes through market basket A shows all baskets that give the
consumer the same level of satisfaction as does market basket A; these include baskets B and D.
Our consumer prefers basket E, which lies above U1, to A, but prefers A to H or G, which lie below
U1.

Note that the indifference curve in Figure 1 slopes downward from left to right. To understand why
this must be the case, suppose instead that it sloped upward from A to E. This would violate the
assumption that more of any commodity is preferred to less. Because market basket E has more of
both food and clothing than market basket A, it must be preferred to A and therefore cannot be on
the same indifference curve as A. In fact, any market basket lying above and to the right of
indifference curve U1 in Figure 1 is preferred to any market basket on U1.

Indifference Map

To describe a person’s preferences for all combinations of food and clothing, we can graph a
set of indifference curves called an indifference map. Each indifference curve in the map shows
the market baskets among which the person is indifferent.
All curves projected on the indifference map must not intersect in order to ensure transitivity.
(https://courses.lumenlearning.com/boundless-economics/chapter/theory-of-consumer-choice/)

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Figure 2. Indifference map

Figure 2 shows three indifference curves that form part of an indifference map (the entire
map includes an infinite number of such curves). Indifference curve U3 generates the highest level
of satisfaction, followed by indifference curves U2 and U1.

An indifference map is a set of indifference curves that describes a person’s preferences.


Any market basket on indifference curve U3, such as basket A, is preferred to any basket on curve
U2 (e.g., basket B), which in turn is preferred to any basket on U1, such as D

Figure 3. Indifference curves cannot intersect

If indifference curves U1 and U2 intersect, one of the assumptions of consumer theory is


violated. According to this diagram, the consumer should be indifferent among market baskets A, B,
and D. Yet B should be preferred to D because B has more of both goods.

Budget Constraints
A budget constraint is a constraint that consumer face as a result of their limited income.

To see how a budget constraint limits a consumer’s choices, let’s consider a situation in
which a woman has a fixed amount of income, I, that can be spent on food and clothing. Let F be

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the amount of food purchased and C be the amount of clothing. We will denote the prices of the two
goods PF and PC. In that case, PFF (i.e., price of food times the quantity) is the amount of money
spent on food and PCC the amount of money spent on clothing

The budget line indicates all combinations of F and C for which the total amount of money
spent is equal to income. Because we are considering only two goods (and ignoring the possibility
of saving), our hypothetical consumer will spend her entire income on food and clothing. As a result,
the combinations of food and clothing that she can buy will all lie on this line:

PF F + PCC = I

Suppose, for example, that our consumer has a weekly income of $80, the price of food is
$1 per unit, and the price of clothing is $2 per unit. Table 3.2 shows various combinations of food
and clothing that she can purchase each week with her $80. If her entire budget were allocated to
clothing, the most that she could buy would be 40 units (at a price of $2 per unit), as represented by
market basket A. If she spent her entire budget on food, she could buy 80 units (at $1 per unit), as
given by market basket G. Market baskets B, D, and E show three additional ways in which her $80
could be spent on food and clothing.

Consumer Choice

Given preferences and budget constraints, we can now determine how individual consumers
choose how much of each good to buy. We assume that consumers make this choice in a rational
way—that they choose goods to maximize the satisfaction they can achieve, given the limited
budget available to them. The maximizing market basket must satisfy two conditions:

1. It must be located on the budget line


2. It must give the consumer the most preferred combination of goods and services.

Effects of Income on Different Goods

Income effects on consumer choice grow more complex as the type of good changes, as
different product and services demonstrate different properties relative to both other
products/services and a consumer’s preferences and utility. As a result, it is useful to outline the
differences in income effects on normal, inferior, complementary and substitute goods:

Normal: A normal good is a good with incremental increases or decreases in utility as quantity
changes, demonstrating a predictable and simple linear relationship as income increases or

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decreases. demonstrates a graphical representation of the effects of income changes upon


preference map.
Inferior: Inferior goods, or goods that are less preferable, will demonstrate inverse relationships
with income compared to normal goods. That is to say that an increase in income will not
necessarily result in an increase in quantity for the inferior good, as the consumer derives minimal
utility in purchasing the inferior good compared to other goods. Inferior goods are often sacrificed
as income rises and consumers gain more choice/options. .
Complementary: Complementary goods are goods that are interdependent in consumption, or
essentially goods that require simultaneous consumption by the consumer. An example of this
would be like purchasing an automobile and car insurance, the consumption of one requires the
consumption of the other. As income increases, these will increase relative to one another.
Substitutes: Perfect substitutes are essentially interchangeable goods, where the consumption of
one compared to another has no meaningful impact on the consumer’s utility derived. Substitutes
are goods that a consumer cannot differentiate between in terms of the need being filled and the
satisfaction obtained. Income increases will thus affect the consumption of these goods
interchangeably, resulting in increase in the quantity of either or both.
(https://courses.lumenlearning.com/boundless-economics/chapter/theory-of-consumer-choice/)ARNING

SUMMARY

The theory of consumer choice rests on the assumption that people behave rationally in an
attempt to maximize the satisfaction that they can obtain by purchasing a particular combination of
goods and services.
Consumer choice has two related parts: the study of the consumer’s preferences and the
analysis of the budget line that constrains consumer choices.
Consumers make choices by comparing market baskets or bundles of commodities.
Preferences are assumed to be complete (consumers can compare all possible market baskets)
and transitive (if they prefer basket A to B, and B to C, then they prefer A to C). In addition,
economists assume that more of each good is always preferred to less
Indifference curves, which represent all combinations of goods and services that give the
same level of satisfaction, are downward-sloping and cannot intersect one another.
Budget lines represent all combinations of goods for which consumers expend all their
income. Budget lines shift outward in response to an increase in consumer income. When the price
of one good (on the horizontal axis) changes while income and the price of the other good do not,
budget lines pivot and rotate about a fixed point (on the vertical axis).
Marginal analysis is the process of comparing the benefits and costs of choosing a little
more or a little less of a certain good.
The law of diminishing marginal utility indicates that as a person receives more of a good,
the additional—or marginal—utility from each additional unit of the good declines.
Utility is the satisfaction, usefulness, or value one obtains from consuming goods and
services.
Opportunity cost measures cost in terms of what must be given up in exchange.

REFERENCES

Books:

Microeconomics 9th Edition, 2018. Robert S. Pindyck, Daniel L. Rubinfeld


Microeconomics: Principles and Applications 5th ed. 2010. Robert E. Hail
Principles of Microeconomics, 2016. Douglas Curtis and Ian Irvine

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E-books:

https://clootrack.com/knowledge_base/what-is-consumer-behavior/
https://www.khanacademy.org/economics-finance-domain/microeconomics/choices-opp-cost-
tutorial/utility-maximization-with-indifference-curves/a/how-individuals-make-choices-based-on-their-
budgetconstraintcnx#:~:text=The%20budget%20constraint%20is%20the,be%20given%20up%20in
%20exchange.https://bizfluent.com/info-8698883-definition-consumer
preference.htmlhttps://courses.lumenlearning.com/boundless-economics/chapter/theory-of-
consumer-choice/

LEARNING CONTENTS
LEARNING

PANGASINAN STATE UNIVERSITY 9

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