Consumer Behavior 4

4.1

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Consumer Behavior 4

The Korean electronics company Samsung makes smartphones. In the run up to the holidays, it needs to add new features to the next version of its Galaxy phone to have a big sales year. The features Samsung will include depend a lot on consumer preferences: how long they need a battery to last, how much memory they use, the type of camera they want, how much they will pay for a larger screen, and so on. Only by figuring out the answers to these questions can Samsung win in the marketplace.

This chapter is about one key question: How do consumers decide which products (and how much of each) to buy? The answer to this simple question is the building block for the demand curve in the basic supply and demand model, and understanding consumer behavior is an incredibly powerful tool with an enormous number of potential applications.

Suppose you manage a grocery store. Pepsi offers to cut your wholesale price if you run a promotion over the coming week. If you drop Pepsi prices by 20%, how many customers will switch from buying Coke to Pepsi? How many customers who wouldn’t have bought any soft drinks before the promotion will buy them now? Understanding how consumers behave can help you make the right decision.
At a nongovernmental organization (NGO) that helps to spur growth in developing countries, a projection of how a country’s consumption patterns change as its people become wealthier will help the organization plan and create the infrastructure to move new goods to the country’s growing markets. Understanding how consumers make their choices is the first step in predicting consumption patterns.
You might need to decide whether to buy a ticket to see a live band or rent a beach house with 10 friends for spring break. How do you decide? Is your method “right”? In this chapter, you’ll learn some simple rules about making choices in the best way.

4.1 The Consumer’s Preferences and the Concept of Utility

4.2 Indifference Curves

4.3 The Consumer’s Income and the Budget Constraint

4.4 Combining Utility, Income, and Prices: What Will the Consumer Consume?

4.5 Conclusion

In addition to teaching you to analyze specific applications like those we just described, this chapter explores a concept you will continue to encounter throughout your lifetime: constrained optimization. When facing decisions, consumers try to do the best they can (they try to optimize) given the constraints they face, like the amount of money they have to spend. To arrive at choices that will make them happiest, consumers must make tradeoffs in the smartest way.

The set of techniques and ways of thinking we use to analyze consumers’ constrained optimization problems will appear repeatedly, with slight modifications, throughout this book and in any economics courses you take in the future. Learn it here and you can use it forever.

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We begin the chapter by discussing the nature of consumers’ preferences (what they like and don’t like) and how economists use the concepts of utility (a measure of a consumer’s well-being) and utility functions to summarize their preferences. Consumers maximize their utility by trading off the purchase of one good against the purchase of others in a way that makes them the happiest. Such tradeoffs depend on a consumer’s preferences, the amount of income the consumer has to spend, and the prices of the goods. We combine these ideas to analyze how consumers behave: why people buy less of a thing when its price rises (i.e., why demand curves slope down), why people consume different things as they get wealthier rather than a lot more of the same things, and so on.