Demand and the Consumer
Marginal Utility Theory • Utility and consumer satisfaction • Total and marginal utility – diminishing marginal utility
• The optimum level of consumption – consumer surplus • marginal consumer surplus • total consumer surplus • consumer surplus and the marginal utility curve
Tina’s marginal utility from petrol 120
MU, P (pence per litre)
110 100 90 80 70 60 50 40 0
250
500 Q (litres per annum)
750
1000
Tina’s marginal utility from petrol 120
MU, P (pence per litre)
110
a
100
Consumer surplus
90
b c
80
MU
70 60 50 40 0
250
500 Q (litres per annum)
750
1000
Marginal Utility Theory • Utility and consumer satisfaction • Total and marginal utility – diminishing marginal utility
• The optimum level of consumption – consumer surplus • marginal consumer surplus • total consumer surplus • consumer surplus and the marginal utility curve
– rational consumer behaviour
Marginal Utility Theory • Utility and consumer satisfaction • Total and marginal utility – diminishing marginal utility
• The optimum level of consumption – consumer surplus • marginal consumer surplus • total consumer surplus • consumer surplus and the marginal utility curve
– rational consumer behaviour • maximising consumer surplus: P = MU
Consumer surplus MU, P
P1
MU
O
Q1
Q
Consumer surplus MU, P
P1
Total consumer expenditure O
MU
Q1
Q
Consumer surplus MU, P
P1
Total consumer surplus
Total consumer expenditure O
MU
Q1
Q
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve
Deriving an individual person’s demand curve MU, P
P1
a
Consumption at Q1 where P1 = MU
MU = D
O
Q1
Q
Deriving an individual person’s demand curve MU, P
P1
a
Consumption at Q2 where P2 = MU
b
P2
MU = D
O
Q1
Q2
Q
Deriving an individual person’s demand curve MU, P
P1
a
Consumption at Q3 where P3 = MU
b
P2
c
P3
MU = D
O
Q1
Q2
Q3
Q
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve – the market demand curve
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve – the market demand curve • the shape of the demand curve
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve – the market demand curve • the shape of the demand curve • shifts in the demand curve
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve – the market demand curve • the shape of the demand curve • shifts in the demand curve
• Limitations of the one-commodity version
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve – the market demand curve • the shape of the demand curve • shifts in the demand curve
• Limitations of the one-commodity version – marginal utility affected by consumption of other goods
Marginal Utility Theory • Marginal utility and the demand curve – an individual’s demand curve – the market demand curve • the shape of the demand curve • shifts in the demand curve
• Limitations of the one-commodity version – marginal utility affected by consumption of other goods – marginal utility of money not constant
Risk, Uncertainty and Insurance • Demand under conditions of risk and uncertainty – the problem of imperfect information
• Attitudes towards risk and uncertainty – defining risk and uncertainty – types of odds – risk attitudes • risk neutral • risk loving • risk averse
Risk, Uncertainty and Insurance • Diminishing marginal utility of income and attitudes towards risk taking – most people are risk averse – diminishing marginal utility of incomes
Total utility of income
Total utility
TU
a
U1
0
5000
10 000
Income (£)
15 000
Total utility of income TU b
Total utility
U2
a
U1
0
5000
10 000
Income (£)
15 000
Total utility of income c
U3
b
U2 Total utility
TU
a
U1
0
5000
10 000
Income (£)
15 000
Total utility of income c
U3
b
U2 U4 Total utility
TU
d a
U1
0
5000
8000 10 000
Income (£)
15 000
Risk, Uncertainty and Insurance • Insurance: a way of removing risks – how insurers spread risks • the law of large numbers • importance of the independence of risks
– problems for insurers • adverse selection • moral hazard
The Characteristics Approach • Consumer choice between products – importance of products' characteristics
• Identifying & plotting characteristics – plotting a product's mix of characteristics
The characteristics of two brands of breakfast cereal
Quantity of fibre
Healthbran
Tastyflakes
f1
h1 t1
f3
O
s1
s3 Quantity of sugar
The Characteristics Approach • Consumer choice between products – importance of products' characteristics
• Identifying & plotting characteristics – plotting a product's mix of characteristics – changes in a product's characteristics
The characteristics of two brands of breakfast cereal
Quantity of fibre
Healthbran
Tastyflakes
f1
h1 t1
f3
O
s1
s3 Quantity of sugar
The Characteristics Approach • Consumer choice between products – importance of products' characteristics
• Identifying & plotting characteristics – plotting a product's mix of characteristics – changes in a product's characteristics
• The budget constraint
The Characteristics Approach • Consumer choice between products – importance of products' characteristics
• Identifying & plotting characteristics – plotting a product's mix of characteristics – changes in a product's characteristics
• The budget constraint – affects how much of each characteristic can be purchased
The characteristics of two brands of breakfast cereal
Quantity of fibre
Healthbran
Tastyflakes
f1
h1 t1
f3
O
s1
s3 Quantity of sugar
The Characteristics Approach • Consumer choice between products – importance of products' characteristics
• Identifying & plotting characteristics – plotting a product's mix of characteristics – changes in a product's characteristics
• The budget constraint – affects how much of each characteristic can be purchased • effects of a change in the budget
The characteristics of two brands of breakfast cereal
Quantity of fibre
Healthbran
f2
h2 Tastyflakes
f1
h1 t1
f3
O
s1
s2
s3 Quantity of sugar
The Characteristics Approach • Consumer choice between products – importance of products' characteristics
• Identifying & plotting characteristics – plotting a product's mix of characteristics – changes in a product's characteristics
• The budget constraint – affects how much of each characteristic can be purchased • effects of a change in the budget • effects of change in a product's price
The characteristics of two brands of breakfast cereal
Quantity of fibre
Healthbran
f2
h2 Tastyflakes
f1
h1 t1
f3
O
s1
s2
s3 Quantity of sugar
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased
The efficiency frontier
Quantity of fibre
Healthbran Assume a given budget and that this is the maximum amount of Healthbran that can be afforded for this budget (assuming no Tastyflakes are purchased) f1
a
Tastyflakes
f3
b
f2
O
The efficiency frontier
c
Alternatively, for the same budget, assume that this amount of Tastyflakes could be purchased (assuming no Healthbran is purchased) s1
s3
s2 Quantity of sugar
The efficiency frontier: four brands Healthbran Oatybix
Quantity of fibre
a b
Tastyflakes
c Sweetreats
d
O Quantity of sugar
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
Consuming a mixture of two products
Quantity of fibre
Healthbran
a
Tastyflakes
c
fall fh
b
d
ft
O
e sh
st
sall Quantity of sugar
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption – indifference curves
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption – indifference curves • plotting indifference curves
Quantity of characteristic A
Choosing between brands
I5
I1 Quantity of characteristic B
I2
I3
I4
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption – indifference curves • plotting indifference curves • the shape of the curves
Quantity of characteristic A
Choosing between brands
I5
I1 Quantity of characteristic B
I2
I3
I4
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption – indifference curves • plotting indifference curves • the shape of the curves
– the optimum consumption point
The Characteristics Approach • The efficiency frontier – shows the different combinations of characteristics that can be purchased • interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption – indifference curves • plotting indifference curves • the shape of the curves
– the optimum consumption point • the tangency point
Choosing between brands
Quantity of characteristic A
Brand 1
Brand 2
a
Quantities of any one of three brands that can be purchased for a given budget at current prices. Brand 2 is chosen Brand 3
b
c
I5
I1 Quantity of characteristic B
I2
I3
I4
Choosing a mixture of brands
Quantity of characteristic A
Brand 1
d
a
Brand 2
b e
I5
c I1 Quantity of characteristic B
I2
I3
I4
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray
Choosing between brands
Quantity of characteristic A
Brand 1
Brand 2
Fall in price of brand 1. d Brand 1 is now chosen a
Brand 3
b
c
I5
I1 Quantity of characteristic B
I2
I3
I4
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income • parallel movement of efficiency frontier
Choosing a mixture of brands
Quantity of characteristic A
Brand 1
d
Rise in income a
Brand 2
b e
I5
c I1 Quantity of characteristic B
I2
I3
I4
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income • parallel movement of efficiency frontier
– changes in a product's characteristics
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income • parallel movement of efficiency frontier
– changes in a product's characteristics • change in slope of product's ray
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income • parallel movement of efficiency frontier
– changes in a product's characteristics • change in slope of product's ray • movement along new ray
A change in the characteristics of Brand 1 Brand 1 (before)
Brand 1 is now chosen
Quantity of characteristic A
Brand 1 (after)
a
c
Characteristics of Brand 1 change Brand 2
b
Brand 2 is chosen
Quantity of characteristic B
I2 I1
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income • parallel movement of efficiency frontier
– changes in a product's characteristics • change in slope of product's ray • movement along new ray
– changes in tastes
The Characteristics Approach • Response to various changes – changes in a product's price • movement along the product's ray • relationship to cross-price elasticity of demand
– changes in income • parallel movement of efficiency frontier
– changes in a product's characteristics • change in slope of product's ray • movement along new ray
– changes in tastes • shift in indifference curves
The Characteristics Approach • Usefulness of characteristics approach – helps understand the nature of consumer choice – helps firms in understanding the effects of making changes • to consumer perceptions – through changing product specifications – by promoting various characteristics through advertising
• repositioning its product
Options open to the firm producing Brand 1
Quantity of characteristic A
Brand 1
e
Effect of lowering prices, or advertising
Brand 2
d Brand 3
a
b
c
I5
I1 Quantity of characteristic B
I2
I3
I4
The Characteristics Approach • Usefulness of characteristics approach – helps understand the nature of consumer choice – helps firms in understanding the effects of making changes • to consumer perceptions – through changing product specifications – by promoting various characteristics through advertising
• repositioning its product • launching a new brand
The Characteristics Approach • Limitations of characteristics approach – problem in measuring characteristics – most products have many characteristics • only two characteristics can be plotted
– problem in identifying indifference curves • hard for one individual • more difficult for whole markets – but can divide markets into segments
– consumer tastes change