Consumer Behavior Theory

1. Utility

1.1. What It Is

• Utility is the degree to which a desire is satisfied and is subjective.
• It has both common characteristics and individual characteristics.
  • Individual characteristics
    • Varies from person to person.
    • Varies over time.
    • Varies by place.
• When economic conditions are good, people may not care much; when economic conditions are poor, they may value it especially highly.

1.2. Types of Utility

• Total utility
  • The total degree of satisfaction obtained from consuming a certain quantity of goods. Represented by TU.
• Marginal utility
  • The increase in utility from consuming one additional unit of a good. Represented by MU.
  • 

1.2.1. Marginal Utility

• 
  • The sum of marginal utility equals total utility.
  • Marginal utility diminishes.

2. The Consumer’s Best Decision

2.1. Why Make Consumption Decisions?

• Income is limited.
• Time is limited.
• Goods are limited.
• Prices change.

2.2. How Does a Consumer Make the Best Decision?

• 
  • Suppose you have 12 yuan. Spend all the money and make every yuan count.
• Rewrite the table using monetary utility.
  • The utility value of one yuan is called monetary utility.
  • 
• Conclusion
  • 

3. Consumer Surplus

3.1. What It Is

• Consumer surplus = willingness to pay - actual payment.
  • Willingness to pay is determined by the size of marginal utility.
• 
  • The lower the price, the greater the surplus.

3.2. Uses

• The government should control the price level.
• The more developed the market economy, the greater the surplus.

4. Tools

4.1. Indifference Curves

4.1.1. What Is an Indifference Curve?

4.1.1.1. Consumer Preferences

• The degree to which consumers like goods.
• Three assumptions
  • Completeness
    • For two bundles A and B, exactly one of A>B, A=B, or A<B must be chosen.
  • Transitivity
    • If A>B and B>C, then A>C.
  • Nonsatiation
    • More quantity is better.

4.1.1.2. Indifference Curve

• The locus of different combinations of two goods that can provide the same level of satisfaction.
  • 
    • Each point represents a combination of X and Y.

4.1.2. Characteristics of Indifference Curves

• There are infinitely many indifference curves, each representing a unique utility level.
• A curve located higher represents a higher utility level.
• Any two curves cannot intersect.
• Convex to the origin.

4.1.3. Special Cases of Indifference Curves

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  • Perfect substitutes.
  • Complements.
  • The normal case is imperfect substitutes.

4.2. Budget Constraint Line

4.2.1. What It Is

• Budget constraint equation
  • 
• Budget constraint line
  • With income fixed, the locus of the maximum combinations of two goods that a consumer can purchase.
  • 
    • Points on the line mean all the money is spent.
    • Points outside the line mean there is not enough money.
    • Points inside the line mean not all the money is spent.

4.2.2. Factors Affecting the Budget Constraint Line

• It is affected by income and prices.
  • 
    • A change in income shifts the line in parallel.
    • A price change rotates the line inward; the opposite change rotates it outward.

4.2.3. Marginal Rate of Substitution

• Used to measure the degree to which goods can substitute for one another.
  • 
• The larger the indicator, the easier substitution is.
• The marginal rate of substitution diminishes.
  • 
    • X0X1 = X1X2, but Y0Y1 > Y1Y2.

5. Consumer Equilibrium

5.1. What It Is

• The consumer’s optimal-choice problem is also called consumer equilibrium.
• With income fixed, the combination of goods a consumer can buy that maximizes utility is called consumer equilibrium.
  • 
  • The curve in the figure is the indifference curve, the straight line is the budget constraint line, and the point where they are tangent is consumer equilibrium.
  • The condition at this point:
    • 

5.2. Changes in Consumer Equilibrium

• Price changes
  • 
    • This curve is called the price-consumption curve: with income unchanged, it is the locus of changes in the consumer-equilibrium position caused by price changes.
  • After price changes, demand also changes.
    • 
      • This curve is called the demand curve.
• Income changes
  • 
    • This curve is called the income-consumption curve: the locus of changes in consumer equilibrium caused by changes in income.
  • After income changes, demand also changes.
    • 
      • This curve is called the Engel curve: the relationship between income and demand for a good.

6. Income Effect and Substitution Effect

• Total effect = income effect + substitution effect.
  • 
    • Substitution effect: a change in relative prices causes product substitution and affects consumer demand; this is called the substitution effect.
    • Income effect: a price change causes a change in real income, which causes a change in consumer demand; this is called the income effect.