Consumer Behavior

Some time ago, General Mills introduced a new breakfast cereal. The new brand, Apple-Cinnamon Cheerios, was a sweetened and more flavorful variant on General Mills’ classic Cheerios product. But before Apple-Cinnamon Cheerios could be extensively marketed, the company had to resolve an important problem: How high a price should it charge? No matter how

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Consumer Preferences

Given both the vast number of goods and services that our industrial economy provides for purchase and the diversity of personal tastes, how can we describe consumer preferences in a coherent way? Let’s begin by thinking about how a consumer might compare different groups of items available for purchase. Will one group of items

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Budget Constraints

So far, we have focused only on the first element of consumer theory—consumer preferences. We have seen how indifference curves (or, alternatively, utility func- tions) can be used to describe how consumers value various baskets of goods. Now we turn to the second element of consumer theory: the budget constraints that consumers face as

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Consumer Choice

Given preferences and budget constraints, we can now determine how individual consumers choose how much of each good to buy. We assume that consumers make this choice in a rational way—that they choose goods to maximize the sat- isfaction they can achieve, given the limited budget available to them. The maximizing market basket must

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Revealed Preference

In Section 3.1, we saw how an individual’s preferences could be represented by a series of indifference curves. Then in Section 3.3, we saw how preferences, given budget constraints, determine choices. Can this process be reversed? If we know the choices that a consumer has made, can we determine his or her preferences? We

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Marginal Utility and Consumer Choice

In Section 3.3, we showed graphically how a consumer can maximize his or her satisfaction, given a budget constraint. We do this by finding the highest indifference curve that can be reached, given that budget constraint. Because the highest indifference curve also has the highest attainable level of utility, it is natural to recast

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Cost-of-Living Indexes

The Social Security system has been the subject of heated debate for some time now. Under the present system, a retired person receives an annual benefit that is initially determined at the time of retirement and is based on his or her work history. The benefit then increases from year to year at a

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Individual Demand

This section shows how the demand curve of an individual consumer follows from the consumption choices that a person makes when faced with a budget constraint. To illustrate these concepts graphically, we will limit the avail- able goods to food and clothing, and we will rely on the utility-maximization approach described in Section 3.3

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Income and Substitution Effects

A fall in the price of a good has two effects: Consumers will tend to buy more of the good that has become cheaper and less of those goods that are now relatively more expensive. This response to a change in the relative prices of goods is called the substitu- tion Because one of

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Market Demand

So far, we have discussed the demand curve for an individual consumer. Now we turn to the market demand curve. Recall from Chapter 2 that a market demand curve shows how much of a good consumers overall are willing to buy as its price changes. In this section, we show how market demand curves

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Consumer Surplus

Consumers buy goods because the purchase makes them better off. Consumer sur- plus measures how much better off individuals are, in the aggregate, because they can buy goods in the market. Because different consumers place different values on the consumption of particular goods, the maximum amount they are willing to pay for those goods

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Network Externalities

So far, we have assumed that people’s demands for a good are independent of one another. In other words, Tom’s demand for coffee depends on Tom’s tastes and income, the price of coffee, and perhaps the price of tea. But it does not depend on Dick’s or Harry’s demand for coffee. This assumption has

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Empirical Estimation of Demand

Later in this book, we will explain how demand information is used as input into a firm’s economic decision-making process. General Motors, for example, must understand automobile demand to decide whether to offer rebates or below-market-rate loans for new cars. Knowledge about demand is also impor- tant for public policy decisions. Understanding the demand

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Demand Theory – A Mathematical Treatment

This appendix presents a mathematical treatment of the basics of demand theory. Our goal is to provide a short overview of the theory of demand for students who have some familiarity with the use of calculus. To do this, we will explain and then apply the concept of constrained optimization. 1. Utility Maximization The

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Describing Risks concerning consumer behavior

To describe risk quantitatively, we begin by listing all the possible outcomes of a particular action or event, as well as the likelihood that each outcome will occur.1  Suppose, for example, that you are considering investing in a company that explores for offshore oil. If the exploration effort is successful, the compa- ny’s stock

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Preferences of consumer Toward Risk

We used a job example to show how people might evaluate risky outcomes, but the principles apply equally well to other choices. In this section, we concentrate on consumer choices generally and on the utility that consumers obtain from choosing among risky alternatives. To simplify things, we’ll consider the util- ity that a consumer

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Reducing Risk concerning consumer behavior

As the recent growth in state lotteries shows, people sometimes choose risky alternatives that suggest risk-loving rather than risk-averse behavior. Most people, however, spend relatively small amounts on lottery tickets and casinos. When more important decisions are involved, they are generally risk averse. In this section, we describe three ways by which both consumers

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The Demand for Risky Assets

Most people are risk averse. Given a choice, they prefer fixed monthly incomes to those which, though equally large on average, fluctuate randomly from month to month. Yet many of these same people will invest all or part of their savings in stocks, bonds, and other assets that carry some risk. Why do risk-

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Bubbles of consumer behavior

During 1995 to 2000, the stock prices of many Internet companies rose sharply. What was behind these sharp price increases? One could argue—as many stock analysts, investment advisors, and ordinary investors did at the time—that these price increases were justified by fundamentals. Many peo- ple thought that the Internet’s potential was virtually unbounded, particu-

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Behavioral Economics 189

Recall that the basic theory of consumer demand is based on three assumptions: (1) consumers have clear preferences for some goods over others; (2) consumers face budget constraints; and (3) given their preferences, limited incomes, and the prices of different goods, consumers choose to buy combinations of goods that maximize their satisfaction (or utility).

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