Demand and Consumer Behavior

Each day involves endless decisions about how to allocate our scarce money and time. Should we eat breakfast or sleep late? Spend our evenings reading or it with friends? Buy a new car or our old one? Spend our income today or save for the future? &we balance competing demands and desires, we make the choices that define our lives. . The results of these individual choices are what underlie the demand curves and price elasticities that we saw in earlier chapter. In this chapter we explore the basic principles of consumer choice and behavior. We shall see how observed patterns of market demand can be explained by the process of individuals’ pursuing their most preferred bundle of consumption goods. We also learn how to measure the benefits that each of us receives from participating in a market economy.

CHOICE AND UTILITY THEORY

In explaining consumer behavior, economics relies on the fundamental premise that people choose those goods and services they value most highly. To describe the way consumers choose among different consumption possibilities, economists a century ago developed the notion of utility. From the notion of utility, they were able to derive the demand curve and explain its properties. What do we mean by “utility”? In a word, utility· denotes satisfaction .. More precisely, it refers to how consumers rank different goods and services. If basket A has higher utility than basket B for Smith, this ranking indicates that Smith prefers A over B. Often, it is convenient to think of utility as the subjective pleasure or usefulness that a pennon derives from consuming a good or service. But you should definitely resist the idea that utility is a psychological function or feeling that can be observed or measured. Rather, utility is a scientific construct that economists use to understand how rational consumers divide their limited resources among the commodities that provide them with satisfaction. . In the theory of demand. we say that people maximize their utility, which means that they choose the bundle; of consumption goods that they most prefer.

Marginal Utility and the Law· of Diminishing Marginal Utility

How does utility apply to the theory of demand? Say that consuming the first unit of ice cream gives you a certain level of satisfaction or utility. Now imagine consuming a second unit. Your total utility goes up because the second unit of the good gives you some additional virility, What about adding a this d and fourth unit 01 the same god? Eventually, if \011 (:.1{ enough ice Carnap. in- .stead of adding to your satisfaction or utility. it makes )011 sick! This leads lii to the fundamental economic concept of marginal utility, When you eat an additional unit of ice cream, you will get some additional satisfaction

or utility. The increment to your utility is called marginal utility. The expression “marginal” is a key tern in economics
and away means “additional”. or “extra” Mia inalienability denotes the additional utility you get from the assumption offal additional unit of a commodity. A century, ago. when economists thought about utility. the)’ enunciated the law of diminishing marginal utility. This law states That the amount of extra or marginal utility declines as a person consumes
more and more of a good. What is the reason for this la\\’: Utility tends to increase as you consume more of a good. However,
according to the law of diminishing marginal utility,  as Yell consume more and more, your total utility will grow at a slower and slower rate. Growth in total utility  slows because your marginal utility (the extra utility)’ added by the last unit consumed of a good) diminishes as more of the good is consumed. The diminishing marginal utility results from the fact that your enjoyment of the good drops off as more and more of it is consumed. .. TIC law III diminishing marginal utility SI;lull’s that. as the amount or a good consumed ins n-awe, the marginal culinary or godhood tends to diminutive.
A Numerical Example We can illustrate utility numerically OI~ill Table fl· J. The table shows in column (2) that total liability «(I) enjoyed increases as consumption (Q) ~rows. but it increases at a deal searing rate, Column (3) measures
marginal nullity a, the extra Gulliver gained when 1 extra unit of the Google is consumed. Thus when the individual consumes !! units, the marginal utility is 7 – 4 = 3 units of Illicitly (call these units “utils”). Focus next on column (S). The fact that marginal utility declines with higher consumption illustrates .rhea law of diminishing marginal utility.

TABLE 5·1. Utility Rise with Consumption
As we consume more food or service like pizza or (‘011′ certs, total utility inn”,.I.’t’ . Tilt: increment of utility from one unit to the next I”~the “marginal Lillian the extra utility added by the ‘( e Ira unit consumed, By the law of diminishing ml the marginalization falls with increasing

Figure 5.1 Oil shows Hierarchically the data on 1(Ital util arid unoriginal Uriel, from Table 5-1 Odd l’P to tilt’ 10- utility ,It each I<:,d of r gumption. III addition. the -moots gray the -betrothed utility level li,r fractious units of consumption. It shows utility increasing, but at a Figure :1-1 (b) depicts marginal utilities or the gamy blocks or virginal utility the assault’ size <IS the cor- Pounding block ugh total utility in (I). The Sat aright black lint’ in (II) is the smoothed curve of marginal utility, The law ugh diminishing marginal utility implies that the marginal utility (MU) curve in Figure 5-1(b) must slope downward. This is exactly equivalent to saying~ that the total utility curve in Figure 5-1 must look concave. like a due. Relationship of Total and Moe,Nolan Utility. Us-lug Figure 5-1, we l’,111 (‘shy see that the total utility of consuming a certain amount is equal to the sum-of the marginal utilities. lip to that point. For example. assume that 3 units are consumed, Column (2) of table 5-1 shows that the total utility is 9 units.  In column (3) we see that the sum of the marginal utilities of the first 3 units is also 4, + 3 + 2 = 9 units., , Examining Figure [)J (/». we see that the total
area under the marginal utility curve at a particular level of consumption-c-as measured either by blocks or by the area under the smooth MU curve-Ill list equal till’ height of the total utility curve shown for tilt’ same number 0(‘ units in Figure 5-1 («). Whether we examine this relationship sustainable or graphs, we see that total utility is the sum of all the marginal utilities that were added from the beginning.

 

FIGURE ,5-1. The Law of Diminishing Marginal Utility
Total utility in (a) rises with consumption. but it rises at a decreasing rate, showing diminishing marginal utility. This observation led early economists to formulate the law of downward- sloping demand. The grey blocks show the extra utility)’ added b)’ each new unit. The fact t~at to~l. utility) increases at a decreasing rate is shown in (b) by the declining of marginal . If we make our units smaller, the steps in total utility are smoothed out and total utility becomes the smooth gray curve in (a). Moreover. smoothed marginal utility. shown in (b) by the black, downward-sloping smooth curve,  becomes indistinguishable from the slope of the smooth curve in (a).

 

History of utility theory Modern utility theory stems from utilitarianism. which has bee” one of the major currents westernmost Intellectual thought of the loot two centuries. The notion of utility taros. soon after 1700. u the mulct Ideas of
mathematician probability were delve loped. Thus Daniel Bernoulli member of a brilliant Swiss dam mathematicians. observed In 1.138 that people act ,u If dollar they scan pin In a fair bet Is worth lieu CO them than dollar they s«and to lose. This means that they are averse to risk and that excessive new oilcan of wealth brine them smaller and smaller-increments of true utility.’ An early introduction of the utilization the special sciences was accomplished by the Denali philosopher Jeremy Bentham (1748-1832). Understudy theory, and under the influence of Adam Smith’s doctrines; Bentham turned to the study of the principles necessary for wind up social legislation. He proposed chat society should be organized-on the “principle of utility,”which he defined as the “property in any object … co produce treasure, good or happiness or to prevent pain.·ed or haplessness.” l All l&!slat ion,accord+ CO Bentham, should be desired on utilitarian principles, to promo. “the ingest happiness of the greatest number:’ Alana ocher Isiah proposals were quite concierge-council Ideas about crime and enshrinement In which he that raising the “pain” to criminals·by harsh punishment would dater crimes. Bentham’s views about utility II elementary CO many people today. But they were cautionary 200 years 1&0 because they attempted that social and economic polities should be designed·to ate’- certain practical results, whereas legitimacy at that time was usually based·on tradition, me” divine right of kings. or doctrinaires. Today, many Poitier~ thinkers defend their ·legislate proposal with utilitarian no-dons of what howl make the largest number of people best off. The next step-in the development of utility theory came when the neoclassical economists-such ass William Stefanie Evasions .(1ST-Ir)-ell.tended Bentham’l utility concept to explain consumer behavior. l~M thought economic theory was a “calculus of pleasure and pain:’ and he developed tn! theory that rational people would base their c<?assumption decisions on the tetra or marginal utility of each good. Many utilitarians of the nineteenth century believed that utility was a psychological reality-directly and cardinally measurable, like length or temperature.

They looked to their weft sentiments for affirmation of the. law of diminished marginal utility Ordinal Utility-economists today generally the notion of a cardinal, measurable util attached to consumption of ordinary goods shoes or pasta, What counts for modern ed theory is the principle of affordability. Under approach, we examine only the preference Ru. of 0 bundles of commodities. Ordinal utils A preferred to B?” Using such preference Windward” we can establish firmly the Genet properties market demand curves described in this chapter and in its appendix.

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