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Module 4 Consumption Theory

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Module 4 Consumption Theory

Uploaded by

Charice Anne Villamarin
Copyright
© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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The

Consumption
Theory
Obj ecti ves
Recognize the importance of understanding
consumer behavior

1 Explain the concepts of utility and the basic


assumptions underlying consumer
preferences

Define what is indifference curve


and explain its properties

Apply the theory of consumer


behavior in business
particularly in marketing
management
The fundamental issue in Microeconomics:

How can a consumer with limited income


decide which goods and service to buy?
3 Distinct Steps to Understand Consumer
Behavior/Elements of Consumer Theory
1. Consumer Preferences
To find a practical way to describe the reasons people might prefer one good to another

2. Budget Constraints
We take into account the fact that consumers have limited income which restrict the
quantities of goods they can buy

3. Consumer Choices
Given their preferences and limited incomes, consumers choose to buy combinations of
goods that maximize their satisfaction.

These three steps are the basics of consumer theory.


1. Consumer Preferences

Basic Assumption About Consumer Preferences:

Steps to
A. Completeness
Consumers can compare and rank all possible baskets.
Understand
For any two baskets A and B, a consumer will prefer A to B,
will prefer B to A, or will be indifferent between the two.
Consumer
When we say indifferent, we mean that a person will be Behavior
equally satisfied with either basket.

A > B B > A A ̴ B
1. Consumer Preferences

Basic Assumption About Consumer Preferences:

Steps to
B. Transitivity
If a consumer prefers basket A over B and he also prefers
Understand
basket B over C, therefore he prefers A over C. Transitivity is
necessary for consumer consistency
Consumer
Behavior
1. Consumer Preferences

Basic Assumption About Consumer Preferences:

Steps to
C. Non-Satiation
More is better than less—Consumers always prefer more
Understand
of any good to less.
Consumer
Behavior
Market Basket or Bundle—the quantities of goods and
services that a consumer buys each month.
Indifference Curves
represent all combinations of market baskets
that provide a consumer with the same level
of satisfaction
Indifference Maps — a graph containing a set of indifference curves
showing the market baskets among which a consumer is indifferent

www.toppr.com/guides/business-economics/theory-of-consumer-behavior/indifference-curve/
Marginal Rate of Substitution
the maximum amount of a good that a
consumer is willing to give up in order to
obtain one additional unit of another
good.

MRS measures the value that the


individual places on 1 extra unit of a
good in terms of another.
Characteristics of Indifference Curves:
1. Negatively sloped
2. Convex to the Origin
3. Do not intersect
Two Extreme Scenarios:
Perfect Substitutes and Perfect Complements

Perfect Substitutes
▪ Two goods for which the marginal
rate of substitution of one for the
other is constant

Remember that two goods are substitutes


when an increase in the price of one leads
to an increase in the quantity demanded of
the other
Two Extreme Scenarios:
Perfect Substitutes and Perfect Complements
Perfect Complements
▪ When two goods for which the MRS is infinite; the indifference
curves are shaped as right angles.

Remember that goods are complements


when an increase in the price of one leads
to a decrease in the quantity demanded
of the other.

www.kenyaplex.com/
Utility
▸ the satisfaction derive from the consumption of a commodity
which determines consumption and demand behavior

Total Utility Marginal Utility


▸ the satisfaction derived from the ▸ the change in utility that results
consumption of a commodity which from a one-unit increase in the
determines consumption and quantity of a good consumed
demand behavior ▸ the additional satisfaction derived
▸ the total amount of satisfaction from consumption of additional
derived from consuming foods and goods and services
services
2. Budget Constraints
Budget constraints are the constraints that consumers face
as a result of limited incomes

Steps to
Budget Line — all combination of goods for which the total Understand
amount of money spent is equal to income
Consumer
Behavior
2 Important things to be analyzed:
▪ Effects of a change in income on the Budget Line
▪ Effects of change in price on the Budget Line
3. Consumer Choices
After our discussion about consumer preferences and budget
constraints, we can now determine how individual consumers
choose how much of each good to buy. We assume that Steps to
consumers make this choice in a rational way—that they
choose goods to maximize the satisfaction they can achieve, Understand
given the limited budget available to them.
Consumer
The maximizing market basket must satisfy two conditions: Behavior
1. It must be located on the budget line
2. It must give the consumer the most preferred combination
of goods and services
Marginal Benefit
benefit from the consumption of one
additional unit of a good
Marginal Cost
Cost of additional unit of a good
Corner Solutions
a situation in which the marginal rate of substitution
for one good in chosen market basket is not equal
to the slope of the budget line
Factors that affect Utility
and Consumption Behavior
Cultural Factors Personal Factors
Values Age and Life-Cycle Stage
Perceptions Occupation
Preferences Economic Circumstances
Behaviors Lifestyle
Personality and Self-concept
Social Factors
Reference Groups Psychological Factors
Family Motivation
Roles and Statuses Perception
Learning
Beliefs and Attitudes
www.simplypsychology.org/maslow.html
Mankiw, Gregory N. (2015). PRINCIPLES OF MICROECONOMICS, Cengage
Learning

Pagoso, C. M., Dinio, R. P., Villasis, G. A., Meneses, P. P., & Veloso, P. P. (2014).
Introductory Microeconomics (Fourth Edition). Manila, Philippines: REX Bookstore.

www.courses.lumenlearning.com/boundless-economics/chapter/theory-of-consumer-
choice/ R eferences
www.courses.lumenlearning.com/boundless-economics/chapter/the-demand-curve-
and-utility/

www.toppr.com/guides/business-economics/theory-of-consumer-behavior/indifference-
curve/

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