2. The Role of Consumers in the Economic Theory

Consumer Behavior

José Manuel Fernández PolancoPatricia Martínez García de Leaniz

DEPARTMENT OF BUSINESS ADMINISTRATION

AREA OF MARKETING AND MARKET RESEARCH

This material is published under:

Creative Commons BY-NC-SA 4.0

2. The Role of Consumers in the Economic Theory

Consumer Behavior

2.1. Assumptions: The Homo Economicus

2.2. Elementary Theory of Supply and Demand

2.3. The Theory of Utility

2.4. Indifference and Choice

2. The Role of Consumers in the Economic Theory

Consumer Behavior

2.1 Assumptions: The Homo Economicus

Homo economicus is the person looking to efficiently maximizehis/her needs or desires. It describes humans as rational andself-interested beings, subjected to constraints, capable ofmaking judgments, using perfect information, towardssubjectively defined ends.

The rational economic actor desires to satisfy her/his needs,does not desire to work if it can be avoided, and is able to findways of achieving targeted goals.

This concept assumes that;

People know what they want and their priorities.People can judge the utility that consuming a good will bring.People can place a value on the utility.People seek to satisfy their own needs at the minimum cost.

2. The Role of Consumers in the Economic Theory

Consumer Behavior

People behave rationally when they,

Search for the cheapest product availableBuy what they need mostSeek to maximise utility with the scarce money availableConsider the opportunity cost of their decisions

But don't behave rationally when they,

Make decisions that are not self-interestedAllow emotions to influence decisionsFollow others rather than thinking for ourselvesMake decisions without all the information they need

2. The Role of Consumers in the Economic Theory

Consumer Behavior

2.2 Elementary Theory of Supply and Demand

Consumers demand goods and services when they buy. Thedemand is the number of consumers willing to buy a product ata certain time for a certain price.

Supply and demand are closely connected. They cause pricesto increase and decrease. When the supply is greater than thedemand, prices go down. When the demand is greater than thesupply, prices go up.

2. The Role of Consumers in the Economic Theory

Consumer Behavior

D

P1

P2

Q1 Q2

Demand: Qd=f(Pd)

S

P1

P2

Q1Q2

Supply: Qs=f(Ps)

S

P

Q

D

P1Surplus

P2 Scarcity

Q2Q1

Equilibrium

2. The Role of Consumers in the Economic Theory

Consumer Behavior

Dynamics of equilibrium

When prices are high, consumers will purchase fewer of thoseproducts. Producers however, will be motivated to make moreproducts to sell when prices are high and they can get moremoney from them.

Sometimes the supply is not available. Then the product isscarce. When scarcity occurs, the prices often increase. Thenpeople must make decisions or choices. When this happens,they must often choose to buy less.

When prices are low, consumers purchase more of thoseproducts. More people can afford to buy them. Producers willthen make fewer of these products to sell because they do notmake much money from them, and the supply will decrease.

2. The Role of Consumers in the Economic Theory

Consumer Behavior

0

01

0

01

PPPQ

QQ

e-

-

=

Price elasticity of demand

Measures consumers’ price sensitivity.

Shows the responsiveness of the quantity demanded of a goodor service to a change in its price. Gives the percentage changein quantity demanded in response to a one percent change inprice.

If |e| > 1® Elastic demand

If |e| = 1® Unit elastic

If |e| < 1® Inelastic demand

2. The Role of Consumers in the Economic Theory

Consumer Behavior

2.3 The Theory of Utility

Needs, satisfaction and utility

Consumers derive utility from the satisfaction of their needs bypurchasing and using goods and services. Utility is the amountof satisfaction obtained when consuming products.

Although it is almost impossible to measure utility, it is usuallypossible to rank the alternatives in their order of preferences tothe consumer.

If U(A) and U(B) are the utilities derived from products A and BAnd A is preferred to Bthen U(A) > U(B)

2. The Role of Consumers in the Economic Theory

Consumer Behavior

The utility function

Assumes increasing utility is directly associated with increasinglevels of consumption. The more you are able to consume, themore utility you derive. But there is a saturation point turning theslope downward.

Utility

Quantity consumed

Total utility

2. The Role of Consumers in the Economic Theory

Consumer Behavior

Law of diminishing marginalutility

Marginal utility is the measure ofrelative satisfaction gained or lostfrom an increase or decrease inthe consumption of a good orservice.

As people consume more units ofa specific product, the utilityderived from the successive unitsgoes on diminishing.

TU Maximum TU

TU curve

Number of units consumed

Zero MU

MU

0

0 Number of units consumed

2. The Role of Consumers in the Economic Theory

Consumer Behavior

2.4 Indifference and choice

Indifference curve

This is a graphic representation ofcombinations of products resultingin the same utility for consumers.

Assuming that more is better,upper curves will result in moreutility, and will be preferred byconsumers.

Q

QQuantity of Good

B

Quantity of Good A

1b

2b

1a 2aQ Q

U3

U2

U1

2. The Role of Consumers in the Economic Theory

Consumer Behavior

Balance constraint

This is a line representing thecombinations of products aconsumer will be able topurchase given current pricesand income.

It changes as income and theprices of the goods change.

Non Affordable

Increasing price of X

Decreasing income

GoodY

GoodX

Max Y

Max X

Affordable

2. The Role of Consumers in the Economic Theory

Consumer Behavior

Individual choice

Point A, where the mostpreferred indifference curve istangent to the budgetconstraint sets the bestavailable combination ofgoods for the consumer.

Combinations in I4 areunaffordable.

Combinations in I2 areaffordable, but result lesssatisfactory.

l3

l2

Good X

Good Y

Al4