Chapter 6: Consumer Behaviour – Microeconomics Study Notes

Consumer Behaviour

Marginal Utility and Consumer Choice

Consumer behaviour in microeconomics focuses on how individuals make choices to maximize their satisfaction, or utility, given their budget constraints. Utility is a central concept in understanding demand and market behaviour.

• Utility: The satisfaction or pleasure a consumer receives from consuming goods or services.

• Total Utility: The overall satisfaction obtained from consuming a certain quantity of a product.

• Marginal Utility: The additional satisfaction gained from consuming one more unit of a product.

• Law of Diminishing Marginal Utility: As a consumer consumes more units of a good, the marginal utility from each additional unit decreases.

• Example: Drinking water when thirsty provides high utility initially, but as more water is consumed, the extra satisfaction from each additional glass diminishes.

Utility Schedules & Graphs

Utility schedules and graphs help visualize how total and marginal utility change as consumption increases.

Number of Bottles of Juice (per day)	Alison's Total Utility ("units")	Alison's Marginal Utility ("units")
1	20	20
2	38	18
3	53	15
4	65	12
5	75	10
6	83	8
7	89	6
8	94	5
9	98	4
10	99	1

Graphical Representation: Total utility increases at a decreasing rate, while marginal utility declines as more units are consumed.

Maximizing Utility

Consumers aim to allocate their income in a way that maximizes their total utility, given the prices of goods and their budget constraints.

• Utility-Maximizing Rule: Consumers should allocate their spending so that the marginal utility per dollar spent is equal across all products.

• Mathematical Condition:

$\frac{MU_X}{P_X} = \frac{MU_Y}{P_Y}$

• Example: If Alison gets more utility per dollar from juice than from burritos, she should spend more on juice and less on burritos until the marginal utility per dollar is equalized.

Rationality and Framing in Consumer Behaviour

Traditional economic theory assumes consumers are rational and always maximize utility. However, behavioural economics shows that choices can be influenced by how options are presented ("framing"), leading to policy interventions called "nudges" that guide choices without restricting freedom.

Consumer’s Demand Curve

The demand curve reflects how much of a product a consumer will buy at different prices, based on utility maximization and the law of diminishing marginal utility.

• Price Change Effect: If the price of a product rises, the marginal utility per dollar spent falls, so consumers buy less. If the price falls, they buy more.

• Downward Sloping Demand Curve: The combination of diminishing marginal utility and utility maximization leads to a negatively sloped demand curve for normal goods.

Income and Substitution Effects of Price Changes

A change in the price of a good affects consumer choices through two channels: the substitution effect and the income effect.

• Substitution Effect: When the price of a good falls, it becomes relatively cheaper compared to other goods, so consumers substitute towards it. This effect always increases quantity demanded when price falls.

• Income Effect: A price decrease increases consumers' real income (purchasing power), allowing them to buy more. For normal goods, this increases quantity demanded; for inferior goods, it may decrease quantity demanded.

• Combined Effect: For normal goods, both effects reinforce each other, resulting in a downward-sloping demand curve.

Giffen Goods

Giffen goods are rare cases where the demand curve slopes upward due to a strong negative income effect outweighing the substitution effect.

• Characteristics:

  • The good is inferior (demand increases as income falls).

  • The good constitutes a large portion of the consumer's budget, so the income effect is large.

Conspicuous Consumption Goods

Some goods are bought for their "snob appeal" or status. While some consumers may buy more at higher prices to signal status, overall market demand is still likely to be downward sloping due to the behaviour of the majority.

Consumer Surplus

Consumer surplus measures the benefit consumers receive when they pay less for a product than the maximum amount they are willing to pay.

• Definition: The difference between the total value consumers place on all units consumed and the total payment made.

• Graphical Representation: The area under the demand curve and above the price line represents consumer surplus.

• Example: If a consumer is willing to pay $10 for a product but buys it for $7, the consumer surplus is $3.

Concept	Graphical Area
Total Value (Willingness to Pay)	Area under the demand curve
Actual Payment	Area under the price line
Consumer Surplus	Area between demand curve and price line

Paradox of Value

The paradox of value explores why essential goods like water have low prices, while non-essential goods like diamonds have high prices.

• Resolution: Price is determined by both demand and supply. Water is abundant, so its marginal value and price are low, even though its total value is high. Diamonds are scarce, so their marginal value and price are high, but their total value is low.

• Key Point: Consumers buy goods until the marginal value equals the market price.

• Example: Water has a low price and high total value; diamonds have a high price and low total value.

Summary Table: Paradox of Value

Good	Marginal Value	Total Value	Price	Supply
Water	Low	High	Low	Abundant
Diamonds	High	Low	High	Scarce

Additional info: These notes expand on the slides by providing definitions, examples, and equations for utility maximization, income and substitution effects, and consumer surplus, ensuring a self-contained study guide for exam preparation.