Consumer Behavior and Transactions

• Consumers are trying to maximize utility, governed by their personal preferences, given budget constraints.

• We can examine Marginal Utility per unit price as a metric for satisfaction per price. In this case the consumer’s goal is to purchase the item with the greatest marginal utility per unit price .

  • The marginal utility calculated here is with respect to the first instance of the product bought.
  • When maximizing this, and when exhausting the budget, the maximizing choice should occur when the marginal utility per dollar spent is the same for all goods. That is

  • The quantity of products which which maximizes the marginal utility per quantity price is called the consumer equilibrium

  • The rule can be reframed differently. We can look at the ratio of prices as an indicator for how much of both goods should be bought. We have that

• Consumer behavior can be affected by income

  • A change in income typically means a change in the budget constraint due to having more disposable income.
  • The income elasticity of demand also affects things.
    • For normal goods, more income = more quantity of the good purchased.
    • For inferior goods, more income = less quantity of the good purchased since better, more expensive alternatives are available.
    • An increase in income means gravitating more towards goods which have high income elasticity of demand.

• Consumer behavior can be affected by price changes

  • A change in price corresponds to a change in the budget constraint, typically a rotation effect ceteris paribus.
  • The typical response to higher prices is to consume less of the good due to two effects
    • Substitution effect - consumers seek a lower-price substitute to the good.
    • Income effect - a higher price means that the buying power of the income decreases.
  • However, a high price can also affect consumption of other goods
    • The consumer may simply continue with their original choices for the high priced product, at the cost of cutting back on the other products.
    • Alternatively, the consumer may simply buy less of the high priced product and by more of the other product as a substitute.

• The Washington Monument Strategy is a strategy where in making budget cuts, it proposes cutting a high utility expenditure (such as a monument). This is a misleading strategy since to really maximize utility, we prioritize cut low utility expenditures first

  • This possibly arises from the subjectivity of utility. A monument, from the perspective of national assets, is merely an attraction. However, to the people they have a (presumed) high utility due to cultural significance.

Information in the Market §

• Many buyers and sellers face imperfect information. Additionally, there is some Information Asymmetry involved.
• Buyers and sellers, however, have incentive to counteract imperfect and asymmetric information.
  • On the seller’s side, there is Reputation to incentivize being honest to the buyers. The following measures enhance reputation
    • Money-back guarantees - encourage people to buy something even if they may not keep it.
    • Warranties - a promise to replace the good for a certain time period.
    • Service Contract - the buyer pays an extra amount and the seller agrees to fix anything that goes wrong (for a set time period)
    • Occupational License - for the Labor market in particular. It certifies a level of quality for a person.
    • Rationale: These methods attract repeat customers which are important for businesses.
  • On the buyer’s side ,there is incentive to be honest about their preferences (similar to here).
    • In the labor market, there may be a trial period to see the quality of work a laborer can provide.
    • In the Financial Market, there may be requirements on having a consigner of the loan who repays some of the money if the borrower doe snot so. Another approach is through collateral which the bank can seize and sell if not paid.
• Severe Imperfect information can thin the market and make buyers and sellers unwilling to participate
• Because of imperfect information, buyers apply heuristics based on the price which may mean that higher price = higher quantity demanded

Links §

• Shapiro, MacDonald and Greenlaw - Ch. 6, 16
• Behavioral Economics is another approach to analyzing consumer behavior which focuses on human “irrationality”