Theory of Consumer BehaviorThis is a featured page

Basics
  • The Theory of Consumer Behavior, like the Law of Demand, can be explained by the Law of Diminishing Marginal Utility.
  • Consumer Behavior is how consumers allocate their money incomes among goods and services.
Consumer Choice and Budget Constraint:
  • Rational behavior:
    • The consumer is a rational person, who tries to use his or her money income to derive the greatest amount of satisfaction, or utility, from it. Consumers want to get "the most for their money" or, to maximize their total utility. Rational behavior also "requires" that a consumer not spend too much money irrationally by buying tons of items and stock piling them for the future, or starve themselves by buying no food at all. Consumers (we assume) all engage in rational behavior.
  • Preferences:
    • Each consumer has preferences for certain of the goods and services that are available in the market. Buyers also have a good idea of how much marginal utility they will get from successive units of the various products they might purchase. However, the amount of marginal & total utility that the people will get will be different for every individuals in the group because all individuals have different taste and preferenes.
  • Budget Constraint:
    • The consumer has a fixed, limited amount of money income. Because each consumer supplies a finite amount of human and property resources to society, he or she earns only limited income.
    • Every consumer faces a budget constraint
    • There is infinite demand, but limited income
  • Prices:
    • Goods are scarce because of the demand for them. Each consumers purchase is a part of the total demand in a market. However, since consumers have a limited income, they must choose the most satisfying combination of goods based partially on prices. For producers, a lower price is needed in order to induce a consumer to buy more of their product.
Utility Maximizing Rule:
  • To maximize satisfaction, a consumer should allocate his or her money so that the last dollar spent on each product, yields the same amount of marginal (extra) utility.
  • When marginal utility are equivalent, consumer is in a equilibrium.
Marginal Utility per dollar:
  • Rational consumers should compare extra utility from each product with its added price.
  • Although spending all of one's income yields the greatest total utility, saving can be regarded as "commodity", that yields utility.
  • MU/$ is found by taking the Marginal utility per good over the price of each good.
    • This can be used to determine a buying pattern, and to help figure out what goods will be bought when.
    • If marginal utility increases, then total utility increases
    • If marginal utility decreases, then total utility decreases
Algebraic Restatement:
  • MU of product A/Price of A = MU of product B/price of B (this is when the consumer is at equilibrium)
  • MU of A = 6units/Price of A = $1 < MU of B = 18units/Price of B = $2, therefore, 6 < 9 (This concludes that the consumer can increase total utility by purchasing more of product B than product A.
  • MUa = MUb
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