Buyer Be Where? Consumer Behavior

1. ECON 1101 Economics for Non-Majors Buyer Be Where? Consumer Behavior Chapter 6 “The consumer, so it is said, is king . . .each is a voter that uses his money as votes to get the things done that he wants done.” Paul Samuelson Nobel Economist

2. What’s the Use? Demand and Utility • Utility • One of the key drivers of buying behavior (consumption) • Value (benefit) you get from consuming a good or service • The utility one consumer gets from a good cannot be compared to utility any other consumer gets from the good (no intercomparability) • The utility one consumer gets from the first good can be compared to utility of subsequent (2nd, 3rd, 4th, etc) goods, and to utility earned from different goods. • Example, the utility I get from consuming a bowl of ice cream cannot be compared to the utility you get. But I can compare the utility I get from ice cream to the utility I get from hamburgers. Ch 6 – Consumer Behavior

3. What’s the Use? Demand and Utility • Utility • Value, benefit, or enjoyment (satisfaction of need or want) that a person receives in consuming a good or service. Ch 6 – Consumer Behavior • Marginal Utility • Value, benefit, or enjoyment (satisfaction of need or want) that a person receives in consuming each additional unit of a good or service. • Diminishing Marginal Utility • Value, benefit, or enjoyment (satisfaction of need or want) that a person receives in consuming each additional unit of a good or service is less than that of the previous unit consumed (marginal utility decreases as we continue to consume additional units of the same good).

4. What’s the Use? Demand and Utility • Economic agents all are working to maximize something: • Firms maximize profit • Governments maximize social welfare • Consumers maximize utility Ch 6 – Consumer Behavior Consumers make choices that will maximize total utility subject to their resource (budget) constraints. Law of Equal Marginal Utility per Dollar Spent: A consumer will consume goods and services up to the point where the marginal utility per dollar spent on each good is equal (or as close as possible) to the MU of the last dollar spent on each good. Mathematically, this is the best a consumer can do.

5. What’s the Use? Demand and Utility Law of Equal Marginal Utility per Dollar Spent: A consumer will consume goods and services up to the point where the marginal utility per dollar spent on each good is equal (or as close as possible) to the MU of the last dollar spent on each good. Ch 6 – Consumer Behavior The marginal utility of a good declines as more of it is consumed in a given time period. As long as marginal utility is positive, total utility must be increasing.

6. What’s the Use? Demand and Utility • Rational behavior requires one to compare the anticipated utility of each expenditure with its cost. • To maximize utility, the consumer should choose that good which delivers the most marginal utility per dollar. Ch 6 – Consumer Behavior • Optimal consumption is the mix of consumer purchases that maximizes the utility attainable from available income. • To maximize total utility, consumers choose the optimal consumption combination.

7. What’s the Use? Demand and Utility • The basic approach to utility maximization is to purchase that good next which delivers the most marginal utility per dollar. Ch 6 – Consumer Behavior • The process continues until the ratios are equal – only then will utility be maximized.

8. What’s the Use? Demand and Utility • The process continues until the ratios are equal – only then will utility be maximized. Ch 6 – Consumer Behavior • Economic theory predicts that the final choices of consumers -- the equilibrium outcome -- will be optimal.

9. What’s the Use? Demand and Utility Diamond Water Paradox • Adam Smith wondered why water, which is necessary to sustain life, is cheap, while diamonds are expensive. • He never figured it out to his satisfaction, but later economists solved this paradox using utility theory: • Water has HIGH total utility, but usually very low marginal utility (water is plentiful – additional glass of water, or additional minute in the shower has low MU). • Diamonds are not consumed as often, so the marginal utility of a diamond is MUCH larger. Many of us will only own one or two diamonds in our lifetimes, so an additional diamond provides greater MU than an additional ounce of water. • MU determines what people are willing to pay for a good, NOT total utility . . . So water is cheaper than diamonds. Ch 6 – Consumer Behavior