chapter 5 - the consumer

Question 1

what is the role of the consumer

Answer 1

provide information on habits/ behaviours - create data used to develop goods/services eg browsing history, GPS data from phones

pay for economic goods - they generate revenue for businesses who can then increase output , invest in expansion etc

consumer demand for goods/services - firms supply goods and services to satisfy consumer demand

one consumers spending is another’s individual income- they provide spending that helps someone earn a wage or receive income

consumers indicate to supplier goods/services they want or do not want- via their spending habits

consumers pay indirect taxes - such as VAT or SSDT to the government

employment is created in meeting the needs to consumers

Question 2

assumptions we make to study consumer behaviour

Answer 2

1.the consumer has a limited income - the consumers income is not large enough to satisfy his/her needs and wants, therefore the consumer must choose between the goods s/he wishes to buy
2.the consumer aims to obtain maximum satisfaction/ utility from their income - a consumer will spend his/her limited income in such a way that s/he will achieve the most satisfaction/best value for money. he will obey the equi- marginal principal of consumer behaviour
3.the consumer acts rationally- the consumer acts in that manner consistent with his preferences. if the person sees an identical commodity priced differently in two adjoining shops they will buy it at the lower price
4. the consumer is subject to the law of diminishing marginal utility - as a consumer consumes additional units of a good their extra satisfaction gained from the additional good will eventually decline

Question 3

are consumers always rational, what can affect their rationality

Answer 3

1.herd mentality- consumers may follow fashions or trends rather than but the thing that they need the most- they may be influenced by their social group, and make decisions that don’t provide them with the highest utility they could achieve
2. the paradox of choice - some choices is good but if overwhelmed it may prevent consumers making rational decisions, as they cant figure out what maximises their utility correctly
3.habitual behaviour (brand loyalty) - some consumers will continue to use the same seller or brand from habit rather than seeking a better version so they may ignore alternatives that could increase satisfaction for them if they were to switch
4. incomplete information - consumers may gather some information but they cant gather it all, and often wouldn’t gather much, so therefore they may make poorer choices based on this. the choice they end up making isn’t the one that would have maximised their utility

Question 4

what are the features of an economic good

Answer 4

1.it must command a price- supply must be scarce in relation to the demand for it. if not people will not be prepared to pay a price to obtain it

2.it must provide a utility- the commodity must provide a feeling of satisfaction. anything which is a nuisance or irritant does not, and so is not an economic good

3. it must be transferable - for an item to be considered an economic good it must be capable of being given from one person to another

Question 5

what are the different ways to measure consumer satisfaction

Answer 5

1.utility - refers to the satisfaction that the consumer gets from consuming a good or service
2.total utility- is the entire satisfaction that a consumer receives from consuming a number of goods or services
3. marginal utility - this is the extra satisfaction a consumer gains from consuming one extra unit of a good

Question 6

the law of diminishing marginal utility

Answer 6

this law states that as a consumer consumes more units of a good the extra satisfaction or marginal utility derived from each additional unit consumed will eventually decline

Question 7

assumptions underlying the law of diminishing marginal utility

Answer 7

1. applies after the origin- the law only applies after a certain minimum quantity of the item has been consumed eg a bowl of cereal equals the origin rather than a single coco pop

2.consumer tastes do not change- it is assumed that consumers tastes remain the same thus utility means the same thing for the commodity in question

3. consumer incomes do not change- it is assumed that consumers incomes do not change in the time period being examined, which would affect consumption patterns
4. no time lapse between the consumption of successive units which permits a change in taste - it is assumed that there is a relatively short time period between consumption points. if you consumed a pizza once a week you could continue to derive the same satisfaction from it, but if you consumed additional pizzas on the same day, the law would kick in

Question 8

exceptions to the law of diminishing marginal utility

Answer 8

1. medicine- the second dose of medicine may as or more important that the first dose ( eg a course of antibiotics), therefore the utility doesn’t decline for the consumer

2.addictive goods- if a consumer is addicted to a good/service, the consumption of additional units of the good may bring even or increased utility than the first good consumed eg alcohol, cigarettes

3. goods/services that require a taste to be developed- some goods may not be enjoyable initially, requiring the consumer to develop a taste for them before gaining increased utility from consuming them eg health food, wine , olives
4. goods that give increasing utility - a consumer may seek certain goods to compliment goods they own, increasing utility as they are consumed
   eg a consumer may receive additional utility from an extra stamp for his stamp collection, an extra sicker for their football sticker book

Question 9

the law of equi marginal principle of consumer behaviour

Answer 9

consumers spend their limited income in such a way that the ratio of marginal utility to price is the same for all the goods/services they buy in order to enjoy maximum utility or satisfaction

MU(A) MU(B) MU(C)
______ = ________ = ______
P(A) P(B) P(C)

Question 10

price elasticity of demand

Answer 10

measures the responsiveness of the quantity demanded of a good following a change in the price of the goods itself

the law of demand states that a rise in the price of a good lowers the quantity demanded and a fall in price of a good increases the quantity demanded. PED measures by how much the quantity demanded responds to a change in price

change in Q p1+P2
___________ x _________
change in P Q1+Q2

Question 11

factors that affect the PED of a good/service (make it more elastic/inelastic )

Answer 11

1. the availability of close substitutes- when a good has a close substitute and its price is increased the demand for the good will be elastic because people will switch to the cheaper substitute. Where a good has no substitutes and its price is increased there is no substitute to switch to and so will be inelastic. the closer substitutability between goods the more consumers will tend to switch their purchasing behaviour in response to a change in relative prices thus the grater will be PED.

2.complementary goods- if the good in question is the cheaper of two goods, which are in joint demand, then the demand for it is likely to relatively inelastic in response to changes in its own price. If the two goods in joint demand are cigarettes and matches, if matches prices increased by 10% we would expect that demand would fall for them by less than 10%

3. is the commodity a luxury or necessity?- it is not a vital that one should possess luxuries and therefore the PED for them will be relatively elastic. in contrast to this, necessities are vital and as such, usually PED inelastic even if prices increase, consumers will continue to buy them.
4. the proportion of income which is spent on the commodity- in general the greater the proportion of income which is spent on a good, the more elastic the demand for it is likely to be, in response to a change in its own price. A rise of 50% in its price of a box of matches is unlikely to have a significant effect on its demand.
5. the durability of the commodity- the more durable the commodity, the more elastic is the demand for it is likely to be in response to a change in its own price. if products such as motorcars increase in price, it is likely that the public will extend the life of their existing
   model and postpone the purchase of a replacement
6. expectations as to future changes in price - if, in the face of a price reduction, the public considers that prices are likely to fall further, they may wait for the further reduction in price, in which case demand may not be very elastic on the initial price reduction.
7. consumer habits/ brand loyalty - a consumer may become strongly attached to a particular product through habit or loyalty to that brand. an increase in price for that good will cause him/her to consume less of the product or to switch to cheaper substitutes. the demand for such goods will therefore be inelastic.

Question 12

income elasticity of demand (YED)

Answer 12

income elasticity of demand (YED) - measures the proportionate change in the demand for a good caused by the proportionate change in income

Y1+ Y2 change in QD
_____________ X _______________
QD1+QD2 change in Y