Consumer Behaviour (Water-Diamond Theory)

CHAPTER 4:
CONSUMER
BEHAVIOR THEORY
Presented by:
Bautista, Aaron Benedict
Gales, Benedict Troy
Mata, Mark Stephen
INTRODUCTION
In the previous lessons, it was said that there

are non-price factors that can affect both
consumers propensity to buy and producers
propensity to sell products.
The Consumers Behavior Theory is where

the law of demand is derived. This is because
the consumers are the ones interested in
buying and consuming products.
There are two approaches in explaining consumer

behavior:
Utility
The
Approach
Budget line and

Indifference curve analyses
THE UTILITY APPROACH

Whenever
a consumers needs or wants are

met, he/she positively achieves a degree of
happiness and satisfaction. In economics, this
want-satisfying ability is called utility.
In
economics, economists rate utility in utils

in a scale from 010, 0 meaning the least
useful or satisfying and 10 meaning the most
useful or satisfying.
THE LAW OF DIMINISHING MARGINAL

UTILITY
In consumer behavior theory, it is expected

that every buyers choice revolves around a
utility-maximization rule, that is, a
consumer buys the product that can provide
him/her with the highest level of satisfaction
or utility. Consequently, whenever the
consumer is faced with a selection of
alternatives, he/she will always choose the
product that will give him/her more pleasure.
The
law of diminishing marginal

utility is the one of the by-products of
the consumer behavior theory. This law
states that a consumer as a consumer
uses up a good or a service, he/ she
tends to get less and less satisfied with
it through time. The greatest satisfaction
is experienced by consuming the first
quantity of the said good.
Two concepts of under the Law of Diminishing Marginal

Utility:
Total
utility is the overall

happiness derived by a consumer
with regard to his consumption of a
product.
Marginal
utility refers to the

amount of additional utility received
in every consumption of an
Total and Marginal Utility for Siomai
Quantity
1
2
3
4
5
6
7
TU
10
19
26
30
30
26
19
MU
--9
7
4
0
-4
-7
Observations from the table
Marginal unity is the change in total utility as we

consume an additional unit of product. Total utility,
therefore, changes relative to the changes in
marginal utility.
Total utility, in general, increases as more and

more units of the product are consumed.
However, at some point, when the marginal utility
is less than 0, total utility decreases.
Marginal utility diminishes as the consumption of

the same good becomes higher (Law of
Diminishing Marginal Utility).
Summary of Utility
MU
TU
Phase I
diminishi Increasin
ng
g
Phase II
Zero
Maximum
Phase III Negative diminishi
ng
THE BUDGET LINE AND

INDIFFERENCE CURVE
In
this approach we assume that a

consumer is capable of consuming any
amount of goods he/she so desires.
In
reality, we are constrained by limited

resources, which include the limited
mean to buy a product at a given price.
The
consumers power to purchase and consume

goods and services are subject to their means.
Hence, in studying consumer behavior, we also
need to consider the buyers limited income and
the price of a particular good or service.
The
utility-maximization rule does not center only

on the amount of satisfaction a consumer gets but
also on the ability to consume more and get
satisfied while spending less.
The
budget line is a graphical representation

of the amount of goods a consumer can afford.
Affordability
depends on the goods price

and the buyers income.
With
this, we can assume that in a budget line,

the amount of total units of goods spent
should not exceed the income of a consumer.
The
indifference curve is a line

illustrating a consumers
responsiveness or indifference
based on a combination of two
products (X and Y). It also shows an
infinite combination of X and Y,
which gives the same level of
satisfaction.
OPTIMUM COMBINATION AND THE

MARGINAL RATE OF SUBSTITUTION
The
optimum combination is the

highest indifference curve that touches
the budget line at a point of tangency.
The
optimum level, a consumer is able

to buy the maximum amount of two
goods given a specific budget.
Budget Schedule
for Goods X and Y
Points Good X Good Y
A
8
0
B
7
1
C
6
2
D
5
3
E
4
4
F
3
5
G
2
6
H
1
7
I
0
8
Indifference
Schedule for
Goods X and Y
Points
J
K
L
M
N
Good X
8
6
4
3
2
Good Y
2
3
4
6
8
EQUIMARGINAL PRINCIPLE
The equimarginal principle states that a

consumer will get maximum satisfaction from
goods X and Y when the MU of the last Peso
spent on good X is exactly the same as the
MU of the last peso spent on good Y, income
being fixed.
INCOME EFFECT AND

SUBSTITUTION EFFECT
An
income effect happens

when the budget line shifted
to the right brought about by
an increase in the consumers
budget or from a decrease in
the prices of goods X and Y.
The
substitution effect or the pivotal

movement of the budget line happens
if there is a decrease in its price and
there is no change in the price of the
good Y. The budget line is still the same,
but consumers choice is now biased
toward the good with the lower price, in
this case good X.
PARADOX OF VALUE
Adam
Smith, an English economist,

presented the Water-Diamond Theory
or Paradox of Value which states that
consumers are willing to give up zero or
little money to get certain products that
give them significant total benefit.
One
refers to value in exchange, as in the case

of diamonds, which is based on its scarcity. The
second type refers to value in use, as in the
case of water, which is based on its importance.
Both
of them have value. Water has more

value in use and less or little value in exchange,
and diamonds has more value in exchange and
less or little value in use.
QUESTIONS
1. What happens if your allowance

increases from PHP 150/day to
PHP 250/day. Would you change
your taste and preference, or
would you stick with your old
consumption patterns?
2. Why do some people

buy expensive branded
things even if they
cannot afford them?
3. Can we apply the law

of diminishing marginal
utility to money? Explain
you answer.
4. What is the
advantage of the
equimarginal
approach?
5. What is the
importance of the
water-diamond
theory?
6. Why do some
people perceive
inexpensive goods
to be less
7. Give some examples

of free goods. Do they
give you satisfaction?
Explain your answers.

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CHAPTER 4:

In the previous lessons, it was said that there

The Consumers Behavior Theory is where

There are two approaches in explaining consumer

Budget line and

THE UTILITY APPROACH

a consumers needs or wants are

economics, economists rate utility in utils

THE LAW OF DIMINISHING MARGINAL

In consumer behavior theory, it is expected

law of diminishing marginal

Two concepts of under the Law of Diminishing Marginal

utility is the overall

utility refers to the

Total and Marginal Utility for Siomai

Observations from the table

Marginal unity is the change in total utility as we

Total utility, in general, increases as more and

Marginal utility diminishes as the consumption of

THE BUDGET LINE AND

this approach we assume that a

reality, we are constrained by limited

consumers power to purchase and consume

utility-maximization rule does not center only

budget line is a graphical representation

depends on the goods price

this, we can assume that in a budget line,

indifference curve is a line

OPTIMUM COMBINATION AND THE

optimum combination is the

optimum level, a consumer is able

The equimarginal principle states that a

INCOME EFFECT AND

income effect happens

substitution effect or the pivotal

Smith, an English economist,

refers to value in exchange, as in the case

of them have value. Water has more

1. What happens if your allowance

2. Why do some people

3. Can we apply the law

7. Give some examples

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