Economics Chapter 10: Consumer Choice and Behavioral Economics

Economic model of consumer behavior
consumers will buy the combo that makes them as well off as possible from all combos budges allow them to buy
Enjoyment or satisfaction people receive from consumption
Difficult to measure directly, economist used to try t in units of utils
Marginal Utility
Change in total utility a person receives from consuming one additional unit
Total Utility
Rises then falls as marginal utility declines until it eventually becomes negative
Height of marginal utility curve
Represents the change in utility as a result of consuming an additional unit
Law of Diminishing Marginal Utility
Principle that consumers experience diminishing additional satisfaction as they consume more during a given period of time
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Budget constraint
Limited amount of income available to consumers to spend
Maximize utility
rule of equal marginal utility per dollar spent
Consumers should consume goods up to the point where
their marginal utilities per dollar spent are equal and the consumer is at the edge of his budget constraint, provided that Marginal utilities are not negative
Utility Maximization formula
MUa/Pa=MUb/Pb and Spendinga+Spendingb=Budget Constraint
Marginal utilities per dollars spent are not equaled
Total utility is not maximized
Rule of equal marginal utility per dollar spent to analyze how consumers adjust buying decisions w/ price change
Income effect
Substitution effect
Income effect
Change in Q demanded of a good that results from the effect of a change in P of consumer purchasing power
*all other factors constant
Substitution Effect
Change in Q demanded of a good that results from a change in price, making good more or less expensive relative to other goods, holding constant the effect of price change on consumer purchasing power.
Changes the opportunity cost of consuming
Income&Substitution effects on diff types of goods
Normal- work together to up or down Q demanded
Inferior- Income effect works in opposite direction, sub always in same direction
Demand curve
Plotting optimal consumption points at different prices
Determine market demand curve
Adding horizontally all individual demand curves
Why is the demand curve downward sloping?
Income and Sub effects work in same direction for normal goods
or Substitution effect outweighs the income effect for most inferior goods
Giffen Goods
upward sloping demand curve
As Q demanded increase as P rises
Exceedingly rare in real life
Social Factors
Culture, customs, religion explain consumer choices
Partly on characteristics of products, partly on how many other people are buying the product
Celebrity endorsements
Cause demand for a product to rise
Network Externalities
Usefulness increases as # of consumers increases
May lead to inferior products as a result of switching costs. Make selection of products path dependent
Inferior VHS systems represent market failures, fail to produce efficient output
Fair pricing
-Ultimatum game recipients would reject unfair allocations of $20
-Price show/game tickets below what could be charged
-Buyers buy together and amount they wish to consume depends on the amount others are consuming
-Business may give up some profits in short run to keep customers happy with fair prices in long run
Behavioral Economics
Study of situations in which people make choices that do not appear to be economically rational
Ignoring Nonmonetary Opportunity Costs
Endowment effect- unwilling to sell good they own even if offered a price > price they would be willing to pay
Nonmonetary opportunity costs are just as real as monetary costs & should be taken into account
Failing to ignore Sunk Costs
Sunk Cost- Cost that has been paid and cannot be recovered
Not let sunk costs impact their decision making
Being unrealistic about Future Behavior
Tendency to overvalue utility of current choices, ex smoking, undervalue utility received in future from choice, ex cancer
Eat a lot today because expect to eat less tomorrow, underestimation of the costs of choices