Microecomonics: Consumer Behavior

1 Microeconomics: Consumer Behavior Introduction Today’s business environment is hyper-competitive and dynamic, thus, for businesses to thrive, they require a better understanding of consumer behavior. Economists and businesses find it necessary to understand consumer behavior because over 70% of the economy is driven by consumption; that is, the trade of commodities. Businesses that seek to maximize their profit must therefore learn what consumers are buying and at what price.

Microeconomics seeks to understand the behavior of people that are willing to purchase goods and services to satisfy their needs, therefore, it studies consumer behavior. A consumer is defined as an individual or organization that creates demand in the market through their decision to acquire goods and services with respect to their budgetary limits and preferences.

A producer exists to satisfy the needs of a consumer, therefore, without a consumer, there would not be a producer. Consumer behavior is an essential component of microeconomics because it facilitates the understanding of the role that people’s preferences and incomes play in not only influencing the demand curve but also shaping the economy.

Buy this excellently written paper or order a fresh one from ace-myhomework.com

2

Literature Review In micro-economics, consumer behavior focuses on consumers, producers and workers, and how they interact with each other in the economy. In the economy, each individual plays a specific role; consumers purchase goods and services, and therefore, are vital to the economy because they are not only the determinants of the level of demand but also the determinants of the quality and quantity of the commodities produced (De Toni, et al.

2017). Producers purchase labor and raw materials to produce goods and services, workers sell their labor while markets provide an avenue for the buying and selling of goods and services among all these parties. From a wide choice of commodities that are available to the consumer, logically, they are most likely to select the alternative that offers the greatest benefit. Relying on these assumtions of benefit maximization and rationality, consumer behavior studies how a consumer’s spending pattern changes with changing prices, and whether their preference and consumption pattern changes with a change in the level of income. According to the consumer theory, the average consumer is perfectly informed about the goods and services that he wishes to purchase, and is assumed to be a rational individual who seeks to make the best use of their resource and does not spend more than their total income or wealth. With regard to the available alternatives, consumer theory assumes that the preferences are complete and that the consumer can rank and make a distinction between the available alternatives. It also assumes that the preferences are transitive, and that the consumer is greedy and thus prefers to have more goods, not less.

In today’s fast-paced and competitive business environment, the marketplace contains different producers each competing to get a larger market share of consumers. As a result of

3 the competition, there is diversity in the price and quality of goods and services offered, in order to serve different market segments (Longenecker, 2010). The variety of goods and services contributes significantly to buyer behavior because it determines their attitudes and behavior towards the products that cater for their market segment and those that do not.

Understanding consumer behavior is essential because it helps marketers understand their markets better and develop suitable marketing strategies to enable them to compete effectively.

The Marshallian economic model states that buyers purchase goods and services that offer the greatest benefit and satisfaction, due to their individual preferences and budgetary constraints. Consumer behavior is therefore highly dependent on the income and ability of consumer’s to substitute a product with another. Therefore, if a consumer is able to derive ulility U from two products, X and Y, such that U = XY, the assumption is that the consumer will be most satisfied when they have the highest quantities of the two factors. Since the purchaser exchanges money for goods and services, they are willing to incur a cost to obtain λ units of utility (Kumar, & Pandey, 2017). The utility of money and the of expenditure at equilibrium are always equal, therefore the economic equation of the decision that the customer makes is expressed as: z = u(x) – λp’x. Z is the highest benefit derived, while x shows the units consumed and p indicates price. λ is the marginal value of money (Kumar, & Pandey, 2017). This equation is known as Marshall’s theory of maximum utility.

The micro-economic analysis of consumer behavior pays particular attention to the interaction between the alteration of commodity prices and the corresponding demand for the product. There is a fluctuation in demand when the price changes because most products and services are not controlled by a monopoly, there are several firms that compete for a share of

4 the market. For most commodities, demand increases with a reduction in price, an demand for the commodity decreases with an increase in the price. This change in demand can be attributed to two factors; the effects caused by income and substitution (Krey, & Rossi, 2017).

When a consumer purchases alternative brands that provide equal or similar benefit this is known as the effect of substitution (Frantz, et al. 2019). Similarly, the effect caused by income fluctuations shows how the consumer’s real income increases when commodity prices are lower, thus resulting in extra income. The additional real income is used to purchase higher quantities of the same or different products. The total price effect, therefore, is the summation of the substitution effect and income effect.

There a number of factors that influence a customer’s decision to purchase a good or service. Consumers have numerous competing needs, some more important than others, thus, assuming rationality, a consumer will attend to their needs in order of the priority. For instance, a consumer who has to choose between paying rent or going on holiday will prioritize paying rent, and save up their extra income to go on holiday. The gradient of the budget limit of the consumer illustrates the proportion at which a consumer can use one product or service instead of another, or can fulfill one need before another. An individual’s budget is determined by their income, as well as how much commodities cost.

If a consumer derives the same level of satisfaction from two products, X and Y, he or she will use either of the products or services indiscriminately to fulfill their need since they derive the same benefits from each of the products. In an indifference curve, there are two products, X and Y, which offer the same benefit to the consumer. Hence, are equally preferred (Frantz, et al. 2019). The conventional name given by economists to a line that shows that two commodities can provide the same benefit to a consumer is known as the

5 Marginal Rate of Substitution (MRS) and it illustrates the proportion at which the user is willing to use one product instead of another, if both offer the same utility.

Products that offer the exact same utility and can be used in place of each other perfectly, and as a result have an indifference curve whose line is straight. However, this is only possible where the quality and price of the substitute goods are at par.

The Optimal Consumers’ Choice To determine the most optimal choice for a consumer, one combines what their budget can afford them, also referred to as the budget constraint, and what their individual preference is, which is the indifference curve. The optimal choice is indicated by the peak of the curve which occurs within the limit of the consumer’s budget. A change in income will have a significant bearing on the commodity that the consumer prefers (Nermend, & Łatuszyńska, 2018). This budget constraint shifts upwards when an individual’s income is higher, and down when the income is lower. When income goes up, the curve will change because consumers will afford more of the product due to the availability of disposable income. However, this is subject to the type of good or service; for normal and Veblen, the consumption of the commodity increases as income increases. However, for inferior goods, consumption reduces as income increases. Changes in commodity prices affect the slop of the curve. When the price reduces, the budget constraint moves outwards, and when the price increases, the budget constraint moved inwards.

How the Consumer Behavior Theory Affects Marketing According to the Marshallian theory, consumers will purchase more of a product when its price is reduced. For instance, if there are two products X and Y that offer the same utility to consumers, a reduction in the price of X will increase its sales, and reduce the sales of Y.

6 However, this only holds true in the assumption that all factors are constant. Consumers are crucial to the economy since they form the market which purchases the goods and services offered by producers. For firms to make sales and generate an income, they must understand the factors that influence demand. There are four elements which have a significant influence on demand; the first being the fact that the quantity of a product that is demanded is dependent on the price at which it is offered to consumers. The second element is how affordable it is to the customers whom it is targeted. This determines whether they are avle to purchase a product, and if they can, and the quantity that is within their budget. Thirdly, the prices of substitute and related products determine which producer they will purchase from, and fourthly, the tastes and preferences of the market also bear a significant influence on the demand for a commodity. The producer can influence the taste and preference of the consumer through advertising.

The Impact of Market Structure on Profit, Cost and Revenue In most competitive markets, there are numerous options of goods and services for consumers to choose from. In fast food markets for example, there are many producers and consumers, each attempting to offer its products in a manner that is distinct from its competitors (Faith, & Agwu, 2018). Due to the vastness of the market, it is impossible for one firm to have control of the market. In the market, firms produce similar, but not completely identical products, and they have a significant level of control of the price.

7

(Source: http://www.economicsdiscussion.net/perfect-competition/how-does-anindividual-firm-reach-equilibrium/25625)

8 (Source: http://economicsmicro.blogspot.com/2008/11/short-run-profit-maximisationin.html) In the short run, a firm can ensure that it achieves maximum revenues and profits by ensuring that the commodity are produced in quantities where the lowest revenue matches the lowest cost. The average revenue (AR) curve is a representation of the summation of the demand. Before industry competition intensifies, the profits generated are considered to be an abnormal profit. The abnormal turnover is unsustainable because it attracts other firms into the industry, causing the supply to exceed demand, thus, resulting in a reduction in the sale price (Chiappori, & Ekeland, 2006). As the price reduces, the average returns (AR) and marginal revenue (MR) shift inwards due to a reduction in revenues.

Conclusion In economic, the consumer is an individual or organization that is the final user of a product. Due to the steep escalation in competition, modern consumers have a wide array of products and services to choose from, thus, demands the better quality, better-prices and innovative product among those available in the market. The study of consumer behavior is a crucial discipline of microeconomics for businesses because it explains the relationship between the price of a commodity, and the resultant demand for it.

9 References Chiappori, P., & Ekeland, I. (2006). The micro economics of group behavior: General characterization. Journal Of Economic Theory, 130(1), 1-26. doi: 10.1016/j.jet.2005.01.007 De Toni, D., Milan, G. S., Saciloto, E. B., & Larentis, F. (2017). Pricing strategies and levels and their impact on corporate profitability. Revista de Administração (São Paulo), 52(2), 120-133. doi.org/10.1016/j.rausp.2016.12.004 Faith, D. O., & Agwu, E. (2018). A review of the effect of pricing strategies on the purchase of consumer goods. International Journal of Research in Management, Science & Technology (E-ISSN: 2321-3264) Vol, 2.

Frantz, R., Cheng, S., Dopfer, K., Heukelom, F., & Mousavi, S. (2019). Routledge Handbook of Behavioral Economics. Routledge.

Krey, N., & Rossi, P. (2017). Springer Shop Find in a library All sellers » My library My History Books on Google Play Back to the Future: Using Marketing Basics to Provide Customer Value. Springer.

Kumar, S., & Pandey, M. (2017). The impact of psychological pricing strategy on consumers' buying behaviour: a qualitative study. International Journal of Business and Systems Research, 11(1-2), 101-117. doi: 10.1504/IJBSR.2017.080843 Longenecker, J. G. (2010). Small business management: Launching and growing new ventures. Toronto: Nelson Education. Krey, N., & Rossi, P. (2017). Springer Shop Find in a library All sellers » My library My History Books on Google Play Back to the Future: Using Marketing Basics to Provide Customer Value. Springer.

10 Nermend, K., & Łatuszyńska, M. (2018). Problems, methods and tools in experimental and behavioral economics. Springer.