The theory of Consumer behavior

• Consumer behavior is the study of • Lauden and Bitta look at consumer

how individual consumers, groups or behavior as the decision process and
organizations; select, buy or use goods physical activity which individuals
and services to satisfy their needs or engage in when evaluating, acquiring,
wants. using or disposing of goods and
• It therefore refers to the actions of services.
individuals in the market place and the
main motives behind those actions.
 Consumers optimization problem
Individuals consumption decision are made
Nature of Consumer behavior with the goal of maximizing total
Consumer behavior is satisfaction from consuming various goods
influenced by; and services,
• Marketing factors such as design, subject to..
price, promotion, packaging,
positioning and distribution. The constraint that spending on goods and
• Personal factors such as age, services exactly equals the individuals
education, gender and income level. money income.
• Social factors such as social status,
and family issues
• Cultural factors such as religion
• Psychological factors such as
buying motive
Consumer theory (ii) Requires that consumers can rank all
consumption bundles based on the level of
satisfaction they would receive from consuming
The consumer theory assumes the various bundles
that;
(i) Buyers are completely
informed about;
• Range of products available
• Prices of all products
• Capacity of products to
satisfy
• Their income
Properties of Consumer preferences
(iii) Non satiation
(i) Completeness More of a good is always preferred
to less
For every pair of consumption bundles, A and B,
the consumer can say one of the following;
• A if preferred to B
• B is preferred to A
• The consumer is indifferent between A and B

(ii) Transitivity
If A is preferred to B, and B is preferred to C,
then A must be preferred to C
Utility • Utility is a psychological phenomenon that
implies the satisfying power of a good or
service
Utility • It differs from a person to person and it
These are benefits consumers depends on persons mental attitude. The
obtain from goods and measurability of utility is always a matter of
services they consume. contention

Utility Function
It shows an individuals
perception of the utility level
attained from consuming each
consumable bundle of goods.
Cardinal Utility approach to
• However, it has been raised with passage of
consumer behavior
time that the cardinal measurement of utility is
not possible and hence less realistic.
 Many traditional economists like • There are many difficulties in measuring
Alfred Marshall hold a view that
utility is measure quantitatively
utility numerically, as utility derived by the
like length, weight, height or consumer from a good or service depends on a
temperatures. number of factors such as mood, interest, taste
 This was based on cardinal or preferences.
measurement of utility for which
these neo classical economists
coined the term “util” as the unit
of utility.
 Accordingly, one util is equal to
one unit of money and there is
constant utility of money.
Assumptions of Cardinal Utility
approach
(ii) Utility is subjective.

This approach is based on the • The consumer is capable of measuring numerically

following assumptions and exactly the satisfaction he gets from the
consumption of goods.
(ii) The consumer is rational. i.e. it
(iii) Utility derived from each commodity is measured in
means that he aims at maximizing monetary units that the consumer is prepared to pay for
his utility given his incomes and another unit.
the prices of commodities
purchased. i.e. he maximizes
utility subject to his budget
constraint. The consumer will
always exhaust his income if he
has to maximize his satisfaction.
Cont;
(vi) All commodities available to the consumer are
perfectly divisible into smaller units.
(vii) Constant marginal utility of money i.e. changes in
(iv) The law of diminishing marginal
income do not affect utility obtained from consumption of
utility operates.
any commodity.
This law states that “as one
consumes more and more units (viii) The consumer utility function is independent of the
of a commodity, the utility utility functions of other consumers. i.e. whether a
consumer decides to buy or not depends entirely on
derived from successive units of
personal preference.
that commodity declines”
(v) It assumes consumption of only one
commodity.
Criticism of the Cardinalist
• Hicks and Allen, following the footsteps of Pareto,
Approach introduced the technique of indifference curves.
• The cardinal utility approach is thus replaced by ordinal
Pareto, an Italian Economist, utility function.
severely criticized the concept of
cardinal utility.
He stated that utility is neither
quantifiable nor addible.
It can, however be compared. He
suggested that the concept of utility
should be replaced by the scale of
preference.
 • In this way, measurement of utility is ordinal
Ordinal utility i,.e. qualitative based on ranking of
preferences for commodities.
• This approach is propounded • For example, suppose a person prefers tea to
by modern economists J.R coffee and coffee to milk. He or she can not
Hinks, R.G.D Allen who tell subjectively; his or her preference. i.e.,.
argue that it is not possible to
measure utility quantitatively.
Tea is better than coffee and coffee is better
that milk.
• Modern economists hold that
“a person can introspectively
express whether a good or
service provides more, less or
equal satisfaction when
compared to one another.
Indifference curves U=f(X,Y)=K

Assumptions of and indifference curve

• An indifference curve is a locus of points –
• Rational consumers
particular combinations or bundles of
goods which yield the same level of utility • Two commodities
(satisfaction) to the consumer so that he is • Utility is measured ordinally
indifferent as to the particular combination
he consumes. • Diminishing marginal rate of substitution
• It shows a combination of two goods that • Consistence and transitivity of choice
gives the same level of satisfaction to the
consumer.
• Each point on the indifference curve shows
that the consumer is indifferent between
the two and all points give him the same
utility.
Properties of an indifference
curve • Indifference Curves analysis

They include the following;

• Negatively and downward
sloping
• Further away from the
origin and indifference
curve lies, means more
satisfaction.
• Indifference curves do no
intersect
• Convex to the origin
Indifference curves
analysis Cont’
Indifference map
MRS Cont’
 Relationship between TU & MU
Marginal Utility
Quantity TU MU
0 0 -
Addition to total utility attributable 1 5 5
to the addition of one unit of a good 2 9 4
to the current rate of consumption, 3 12 3
holding constant the amounts of all 4 14 2
other goods consumed. 5 15 1
6 15 0
7 13 -2
MU

Consumer equilibrium
Under cardinal approach, the consumer is in
equilibrium when he equates marginal utilities of goods
consumed to the prices paid for those goods.
MU(X) =Px (X)
Consumers Budget line • A budget line therefore shows all the
combinations of two goods.
It Shows all possible commodity • The consumer can buy spending his given
bundles that can be purchased at money income at their given prices
given prices with a fixed money
income. • All those commodities which are with in the
In an attempt to attain more and reach of the consumer will lie on the budget
more satisfaction, the consumer line.
experience two major constraints;
(i) He has to pay the prices for
goods and services
(ii) He has limited money income
with which to purchase the
goods
Budget line Cont’
 Derivation of demand curve
under cardinal utility approach
This can be based on the following assumptions:

 The law of diminishing marginal utility operates

 Utility is measurable in monetary terms.
 A single commodity is consumed.
 The commodity is a normal good.
 Consumer’s income is fixed.
 Consumer tastes and preferences do not change.

• Basing on the above assumptions and if MU is measured in monetary

units then the demand curve of the commodity is identical to the
positive part of the MU curve.
• When TU is maximum, MU = 0

• When TU is increasing, MU is
positive.

• When TU is falling, MU is negative.

Also, P3>P4 and MU3 > MU4

• The negative part of the MU does not

form part of the demand curve
because in economics, negative
quantities and negative prices do not
make sense.
Market demand and marginal benefit
• Derivation of market demand