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The topic of consumer behavior is most concerned with how people make their buying decisions in an economy. In the American mixed economy consumers are free to choose which goods and services to purchase. This freedom of choice is best demonstrated when consumers cast their dollar votes for or against products. Naturally, consumers are not financially able to buy unlimited quantities of products. Instead, consumers must make choices, and these choices are influenced by many factors.

One important factor that influences consumer choice is the budget constraint that confronts every household. Recall from Chapter 2 that a household's budget constraint is determined by two factors: household income and the price of products. That is, people are able to buy more goods and services if their income increases or the price of goods decreases. Conversely, people are able to buy fewer products if their income decreases or the price of goods increases. In addition to budget constraint, four other factors affect consumer behavior: the perceived utility of a good, the income effect of a price change, the substitution effect of a price change, and consumer surplus. An understanding of these factors enables businesses, among others, to predict certain consumer behaviors.

Utility Theory

Utility reflects the amount of satisfaction a person receives from the consumption of a good or service. Economists measure the utility of a purchase in “utils,” or units of satisfaction. In reality, people's tastes and preferences for products vary and therefore, a precise comparison of the utility of one product against a second product is impossible. Yet as a general principle, people tend to buy goods and services that offer them the highest utility, or satisfaction, per dollar spent. Pivotal to consumers' buying decisions is the law of diminishing marginal utility, which states that as additional units of the same product are consumed in a given period of time, the amount of additional satisfaction, the marginal utility, will decline.

Consider the utility for slices of pizza shown in Figure 4.1. In this hypothetical situation, Liam derives the greatest utility, 15 utils, from the first piece of pizza. Total utility rises when the second and third pieces of pizza are consumed because each slice results in some additional satisfaction. Note, however, that the marginal utility falls as additional slices are consumed, from 15 utils for the first slice, to 10 utils for the second slice, to 5 utils for the third slice. This diminishing marginal utility reflects the incremental reduction in satisfaction for slices of pizza consumed in a certain time period. In fact, by stuffing himself with the fourth and fifth slices of pizza, Liam encounters zero and then negative marginal utility. A graphic depiction of the downward sloping marginal utility curve is also shown in Figure 4.1.

An understanding of diminishing marginal utility offers important insights into consumer behavior. Foremost, it helps explain why a consumer might be willing to pay a high price for the first unit of a product that is consumed but a lower price for additional units. Liam may be willing to pay a high price, say $3, for the first pizza slice because it offers him such a high degree of satisfaction (15 utils). But he may not be willing to pay the same $3 per slice for the second (10 utils), third (5 utils), or fourth (0 utils) pizza slices because these

Liam's Utility from the Consumption of Slices of Pizza

Figure 4.1 Liam's Utility from the Consumption of Slices of Pizza

later slices offer less and less satisfaction. Businesses also understand the law of diminishing marginal utility. For example, businesses often advertise the first item at the regular price and the second identical item at a reduced price. This sales technique helps increase the quantity demanded of many consumer goods ranging from toothpaste and deodorant to sweatshirts and shoes—and pizza slices.

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