Business Economics 04 Consumer Behaviour

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  • 1. Consumer behavior
  • 2.
    • Discussion
    • Utility - Cardinal and Ordinal
    • Total utility and marginal utility
    • Indifference curve analysis
    • Revealed preference theory - concept
    • Using the characteristics for demand analysis- concept
    • Behavioral perspectives on decision making
  • 3.
    • Utility – subjective, post consumption satisfaction, user specific, ethically neutral, changes with time, perception and income.
    • Cardinal utility (Jevons, Menger, Walras, Marshall)
    • Ordinal utility (Slutsky, Pareto, John Hicks)
  • 4. Cardinal utility
    • Total utility
    • Marginal utility
  • 5. Principle of diminishing marginal utility
    • As a person continues the consumption of a good with ceteris paribus condition, the total satisfaction derived will increase but at decreasing rate.
  • 6. Neha’s utility from consuming crisps (daily) Packets of crisps consumed TU in utils MU in utils 0 0 0 1 7 7 2 11 4 3 13 2 4 14 1 5 14 0 6 13 -1
  • 7.
    • The ceteris paribus assumptions
    • Are there any goods or services where consumers do not experience diminishing marginal utility?
  • 8. Utility/welfare measurements
      • Consumer surplus - the excess of what a person would have been prepared to pay for a good (i.e. the utility) over what that person actually pays
      • Marginal consumer surplus - the excess of utility from the consumption of one more unit of a good (MU) over the price paid :
    • MCS = MU - P
  • 9.
    • Total consumer surplus - the excess of a person’s total utility from the consumption of a good (TU) over the amount that a person spends on it (TE):
    • TCS = TU - TE
    • Rational consumer behavior - people will go on purchasing additional units as long as they gain additional consumer surplus (MU>P)
  • 10.  
  • 11.
    • Optimum level of consumption - MU = P
    • If a good were free, what would be the level of consumer surplus?
    • MU and demand curve
  • 12. Water-Diamond Paradox
    • What determines the market value of a good?
    •   Karl Marx and David Ricardo- value depends on the amount of resources used
    •   Adam Smith (1760s) – ‘ How is it that Water which is so essential to human life, and thus has such a high ‘ value-in-use ’ , has such a low market value? And how is that diamonds which are relatively so trivial have such a high market value? ’
  • 13.
    • MU revolution in 1870s - Jevons(UK) Carl Mager(Austria) and Walras(Switzerland) claimed that the source of market value is its MU, not its TU.
    • Diminishing marginal utility of income- moral argument for redistributing income
  • 14.
    • Drawbacks
    • Weaknesses of the one commodity version of marginal utility theory
    • Effects on substitutes and complimentary goods and leftover income
    • Constant marginal utility of money
  • 15.
    • The Equi-marginal Utility Principle - the optimum combination of goods consumed - consumer will get the highest utility from a given level of income when the utility from the last re.1 spent on each good is the same.
  • 16.
    • Suppose Px=2/- and Py=2/-, I=20/-, and he spends it all on X and Y.
    • State the equilibrium for this individual
    • If “commodity” Y is savings, how would the equilibrium condition be affected
    • Suppose that MUx increased continuously as the individual consumed more of X while MUy remains constant, how should the consumer rearrange his expenditure to maximize utility
    Exercise Q 1 2 3 4 5 6 7 8 9 10 11 Mux 15 14 11 10 9 8 7 6 5 3 1 Muy 15 13 12 8 6 5 4 3 2 1 0
  • 17. Ordinal utility- Indifference curve analysis
    • Consumer Preferences
    • Budget Constraint
    • Basic Assumptions
    • Completeness- preferences ignore costs
    • Reflexivity- bundle is as good as others
    • Transitivity- preferences are consistent and rational
    • More to Less
  • 18.
    • Indifference curve - a line showing all those combinations of two baskets of goods between which a consumer is indifferent
    • Characteristics of an IC
    • slopes downward to right
    • two ICs cannot intersect each other
    • higher IC gives higher level of satisfaction
    • convex to origin
  • 19.
    • Marginal rate of substitution (MRS) between two goods in consumption
    • Diminishing MRS
    • Indifference map
    • Budget constraint
  • 20. Which of the following diagrams correspond to which of the following?
    • x and y are left shoes and right shoes.
    • x and y are two brands of the same product, and the consumer cannot tell them apart.
    Y O X Y O X
  • 21.
    • Optimization of satisfaction by consumer
    • MRSxy = Px/Py
    • Px/Py = MRSxy = Mux/Muy =  X/  Y
    • Px/Py = Mux/Muy
    • Mux/Px = MUy/Py
  • 22.
    • The effect of changes in income
    • Real income
    • Income-consumption curve
    • The effect of change in price
    • Price-consumption curve
  • 23.
    • Price effect = Substitution effect + Income Effect
    • Income effect of a price change
    • Substitution effect of a price change
    • Compensating variation – excludes the change in real income
  • 24. Giffen goods - accounting for large proportion of consumer expenditure which leads to significant effect on the real income resulting in abnormal income effect outweighing normal substitution effect
  • 25. Application of indifference curve analysis
    • Choices by consumers
    • Buy one large pizza, get one large pizza free (limit one free pizza per customer)
  • 26. Exercise While at a discount shoe store, a customer asked a clerk, “I see that your shoes are ‘buy one, get one free- limit one free pair per customer: will you sell me one pair for half-price?” The clerk answered, “I can’t do that,” when the customer started to leave the store, the clerk hastily offered, “however, I am authorized to give you a 40% discount on any pair in the store.” Assuming the consumer has Rs.2000/- to spend on shoes (x) or all other goods (y), and that shoes cost Rs.1000/-per pair, answer the following questions:
  • 27.
    • A) Illustrate the consumer’s opportunity set under the ‘buy one, get one free deal’ and under a 40% discount
    • B) Why was the 40% discount offered only after the consumer rejected the ‘buy one, get one free’ deal and started to leave the store?
    • C) Why was the clerk willing to offer a ‘buy one, get one free’ deal but unwilling to sell a pair of shoes for half-price?
  • 28.
    • Choice by consumer cont.
    • Gifts – cash or in-kind
    • Choices by workers and managers
    • A simplified model of income-leisure choice
  • 29.
    • The decision of a manager
    • Valuing output and profit both
    • Valuing output only
    • Valuing profit only
  • 30.
    • Limitations of IC Analysis
    • Difficult to derive ICs
    • Consumers may not be rational
    • Difference between expected satisfaction and gained satisfaction
    • Not applicable in case of consumer durables
  • 31.
    • Revealed Preference Theory
    • Assumptions
    • Taste does not change
    • Consistency
    • Transitivity
    • Consumer induced to purchase any basket of goods if its price is made sufficiently attractive.
  • 32. The demand for characteristics - Lancaster’s approach to demand
    • Goods demanded for their characteristics
    • A good may possess more than one characteristics
    • Style, flexibility, after sales service etc.
  • 33.
    • The advantages
    • Substitute goods explained in terms of possessing some common characteristics
    • The introduction of new goods
    • The effect of changes in quality
  • 34.
    • Assumptions
    • More than one characteristic
    • Mix of characteristics which differs from one product to the next
    • Good with similar characteristics are possible substitute
    • Product characteristics measured which is objective
    • The number of products on the market exceeds the number of product characteristics allowing for competition between products.
  • 35.
    • The two characteristics approach
    • Price changes – brand loyalty
    • Income changes - inferior goods and saturation
    • Gaps in the market
  • 36.
    • Mobile operators to launch interactive FM radio services Thomas K Thomas
    • Visuals and song related details among services being offered
    • New Delhi , July 23
    • Now you can watch visuals while you listen to FM radio on your mobile handset. Mobile operators including Airtel and Hutch are all set to launch a new service called `Visual Radio' which will enable users to get visuals, information and details related to the song and the singer while listening to the radio. The service will also enable users to download the song as ring tone and interact live through quizzes and audience polls.
    • Launch soon
    • While Airtel is ready to launch this service by the end of the month, Hutch is announcing the launch this week. The subscribers do not have to pay any subscription fee for the service for now but once the introductory offer period is over the operators may fix a monthly fee. However, users will have to pay in case they download the song or participate in the interactive services. Both the operators have tied up with Radio Mirchi, Hewlett Packard and Nokia for the service.
    • Services offered
    • Visual Radio offers immediate access to factual content related to the songs playing, the group or the singer playing, their background details, history, related quizzes, participation in audience polls and even the facility to download ring tones and wallpaper related to the song. Mobile users can also buy the tickets for concerts or movies from which the song is being played.
    • "Images and texts are synchronised with the radio broadcast to bring information and interactivity directly to the mobile phone. Research indicates that people listen to 63 minutes of radio on an average day. Can you imagine enhancing their daily experience multiple-fold through the visual medium? That is exactly what we are doing for our Airtel customers. This service is a great example of technologies converging on the mobile and this means that Airtel customers can view related information and other exciting entertainment while listening to their favourite songs," said Mr Sanjay Kapoor, Joint President Mobility, Bharti Airtel Ltd.
  • 37.
    • Weaknesses of Lancaster’s model
    • Not all characteristics can be measured objectively
    • Different consumers may see the same product or brand representing the same characteristics but in different ratios
  • 38.
    • It is important to learn how different combinations of the characteristics of a product yield more or less satisfaction
    • Goods having similar characteristics may not be substitute for one another – consumer’s choice
    • Suitable incase of divisible and non-durable products .
  • 39.
    • Exercise
    • Draw a figure that shows a hypothetical equilibrium for the consumption of honey and sugar and for their two attributes calories and sweetness
    • 33% increase in the consumer’s income
    • 40% reduction in the price of honey (with no change in the price of sugar and in consumer’s income)
    • Competitive saccharin is introduced with more of sweetness and less of calories.
  • 40.
    • (d) How could producers of sugar regain the market?
    • (e) If saccharin is very profitable, what quality changes are producers of honey stimulated to introduce? How would these quality changes be reflected ?