Theory of Consumer Behavior

FACTORS
CULTURAL

SOCIAL

PERSONAL

PSYCHOLOGICAL

BUYER
 FACTORS
CULTURAL

- exert the broadest and deepest influence

on consumer behavior.
- is one of the most fundamental
determinants of a person’s wants and behavior.
 FACTORS
Social Factors

- A consumer’s behavior is also influenced

by social factors such as the consumer’s
reference groups, family, and social roles and
statuses.
 FACTORS
Personal Factors

- A buyer’s decision are also influenced by

personal outward characteristics such as: the
buyer’s age and life cycle, lifestyle,
personality, and self-concept.
 FACTORS
Psychological Factors

- A person’s purchases are also influenced

by psychological factors: motivation,
perception, learning, and beliefs and attitudes.
 Consumer preferences and utility
• How can we possibly model the decision of
consumers ?
– What will they consume?
– How much of each good?
 Consumer preferences and utility
• “general rule”:
– A rational consumer will always choose the best
basket of goods amongst all the ones it can afford
• But we need to clarify :
– What we mean by rational
– What we mean by best
– What we mean by afford
 Theory of Consumer Behavior
• Utility - amount of satisfaction derived from the
consumption of a commodity

• Utils - measurement units

 Theories of Consumer Choice
• Utility Concepts:
– The Cardinal Utility Theory
• Utility is measurable in a cardinal sense
• cardinal utility - assumes that we can assign
values for utility, (Jevons, Walras, and Marshall).
E.g., derive 100 utils from eating a slice of pizza
– The Ordinal Utility Theory
• Utility is measurable in an ordinal sense
• ordinal utility approach - does not assign values,
instead works with a ranking of preferences.
(Pareto, Hicks, Slutsky)
 The Cardinal Approach
• Total utility (TU) - the overall level of satisfaction
derived from consuming a good or service
• Marginal utility (MU) additional satisfaction that an
individual derives from consuming an additional
unit of a good or service.
Formula :
MU = Change in total utility
Change in quantity
= ∆ TU
∆Q
= TU2-TU1
Q2-Q1
 EXAMPLE
Beers Total Marginal
consumed Utility Utility
0 0 0
1 10 10
2 15 5

3 18 3

4 18 0

5 17 -1
 The Cardinal Approach
• TU, in general, increases
with Q
• At some point, TU can start
falling with Q (see Q = 5)
• If TU is increasing, MU > 0
• From Q = 1 onwards, MU is
declining  principle of
diminishing marginal
– utility  As more and
more of a good are
consumed, the process
of consumption will (at
some point) yield
smaller and smaller
additions to utility
 The Cardinal Approach
• Law of Diminishing Marginal
Utility (Return) = As more and
more of a good are consumed,
the process of consumption
will (at some point) yield
smaller and smaller additions
to utility
• When the total utility
maximum, marginal utility = 0
• When the total utility begins to
decrease, the
marginal utility = negative (-)
 The Cardinal Approach
• Problematic concept of cardinal:
– Is it possible to quantify the satisfaction derived from
consuming a good ?
– Is it possible for the quantities of utility derived from 2
different goods to be compared ?
– More importantly, do consumers actually think that way
when they choose goods ???
• This problem was solved by the introduction of ordinal utility
– More general, more realistic and more powerful
 The Ordinal Approach
 Ordinal utility is a representation of preferences
(x1 , x 2 ) ( y1 , y2 ) if U(x1 , x 2 )  U( y1 , y2 )

( y1 , y2 ) ( x1 , x 2 ) if U( x1 , x 2 )  U( y1 , y2 )

(x1 , x 2 ) ( y1 , y2 ) if U(x1 , x 2 )  U( y1 , y2 )
 It is not the ability to quantify « how much » utility is provided
by a bundle, but the ability to rank bundles in order of
increasing utility
 This is much closer to the “real” behaviour of agents
 The Ordinal Approach
• Assumption using Ordinal Approach
– Preferences are complete :
• Agents can always rank bundles (i.e. preferences exist for all
possible bundles)
– Preferences are transitive :

If ( x1 , x 2 ) ( y1 , y2 ) and ( y1 , y2 ) (z1 , z 2 )
 ( x1 , x 2 ) (z1 , z 2 )
 The Ordinal Approach
• Ordinal utility holds that utility cannot be measured
but can be ordered according to consumers’
preferences.
• Different product combinations may be viewed as
having same utility
• And these combinations of same utility consist of one
Indifference Curve (IC).
• Indifference curve - A locus of points representing
different bundles of goods and services, each of which
yields the same level of total utility.
Increasing
satisfaction
 Utility Constraints
• Income
• Price
In a 1/2 sheet of paper make a wise decision and
write what is the best/optimal decision of pizza
and spaghetti should a consumer choose given
the constraints below:
Income =P450.00
Price of Pizza = P22.50/slice
Price of Spaghetti = P45.00/plate
POSSIBLE COMBINATIONS

ADD ROWS IF NECESSARY

Income =P450.00
Optimal Choice (OC)
Price of Pizza = P22.50/slice
Price of Spaghetti = P45.00/plate
Steps to find the Optimal Choice:
1. Derive the Budget Function I  P1 X  P2Y
 Y-intercept and X- intercept for the budget line
2. Find the Marginal Rate of Substitution (MRS)
 the rate at which the consumer is willing to substitute one good
for another good
 MRS = QY ÷ QX
 Y-intercept/X-intercept (of the budget line)
 quantity of goods Y willing to substitute to obtain a certain
unit of goods X & this substitution is to maintain its
position at the same level of satisfaction
 Indifference curve slope
 Optimal Choice (OC)
3. Find the tangency condition Y=Pizza
20
or the optimal condition 19
– the combination 18
17
wherein the budget is 16
exhausted that gives the 15
14
highest level of 13
satisfaction and such 12
11
combination is equal to 10 IC4
the ratio of MRS 9 IC3
8 IC2
– highest indifference 7 IC1
6 Tangency
curve that touches the 5
Condition
to the budget constraint 4 Budget Line
3
– slope of the budget line 2
1
is equal to the MRS of 0
an indifference curve 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
X=Spaghetti