Consumer Behavior Analysis Report: Microeconomic Principles

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Economics
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Table of Contents
1. Briefly discuss the following terms.............................................................................................3
a. Consumer’s Indifference Curve...................................................................................................3
b. Marginal Rate of Substitution......................................................................................................4
c. Consumer’s Budget Constraints..................................................................................................5
d. Diminishing Marginal Utility......................................................................................................5
e. Income and Substitution Effects..................................................................................................5
2. Explain ‘Behavioural Economics’ and critically evaluate the reasons behind irrational
behaviours of consumers.................................................................................................................7
Reference list...................................................................................................................................9
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1. Briefly discuss the following terms
a. Consumer’s Indifference Curve
As stated by Oliveira-Castro et al. (2015), one can be defining indifference curve as the graph
that shows the combination of two differing goods, which yield same level or equal level of
utility and satisfaction to consumers. The consumer’s indifference curve gives an implication
that the consumer is indifferent in nature between the two goods and at all the points of the
curve, the satisfaction or the utility that it yields to the consumer is equal in nature (Guo and
Chen, 2018). For example, Mr. Johnson is a consumer, who has two combinations of clothing
and food that gives equal satisfaction level to him. The following are the four other combinations
determined from through asking Mr. Johnson varying questions -
Combination Clothing Food
A 12.0 1.0
B 6.0 2.0
C 4.0 3.0
D 3.0 4.0
Table 1: Combinations of Mr. Johnson
(Source: Created by the learner)
Based on the above combinations, the following is the consumer’s indifference curve drawn for
Mr. Johnson -
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Figure 1: Consumer’s indifference curve
(Source: Created by the learner)
b. Marginal Rate of Substitution
Another significant concept in the field of economics is the marginal rate of substitution, which
is also known as the MRS (Liu and Lv, 2018).
According to Ouellette and Vigeant (2016), one can define the marginal rate of substitution as
the amount of any commodity, which any consumer is willing to be giving up for another
commodity, as long as the new commodity seems equally satisfying in nature. This concept is
put to use in the indifference theory in order to conduct an analysis of behaviour of consumers.
The computation of the marginal rate of substitution between two differing commodities is
computed through the means of placing the two commodities over an indifference curve, thereby
highlighting a frontier of equal level of utilities for every combination of “Commodity A” and
“Commodity B”. It is through the following formula that marginal rate of substitution is
computed -
| MRS xy | = D y / D x = MU x / MU y
Wherein,
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x and y = Two differing commodities
D y / D x = Derivate of the commodity ‘y’ with respect to that of commodity ‘x’
MU x / MU y = Marginal utilities of the commodities of x and y
c. Consumer’s Budget Constraints
Within the field of economics, one can be referring to a budget constraint as each of the
combinations of products and services, which consumers might be buying given present prices
within the consumer’s presented income (Khan et al., 2018). Consumers usually try on
maximising his or her satisfaction. However, in this pursuit, the consumer is hampered due to the
limited amount of money income, which is the budget. Budget lines are known as the
purchasable combinations of two differing purchasable commodity combinations, given the
prices of every good and the income of consumers. Therefore, the budget constraints explain
differing amount of two different commodities, which a consumer could be affording and occurs
whenever consumers are limited in terms of their consumption patterns due to a specific income.
d. Diminishing Marginal Utility
One of the fundamental concepts or laws in the subject of economics is the ‘diminishing
marginal utility’. Marginal utility could be defined as the additional satisfaction that consumers
could be obtaining one extra unit of an item (Monnot, 2017). The law of diminishing marginal
utility says that as any consumer starts consuming higher and higher units of a particular
commodity or service, the utility that is derived by them from the successive units keeps on
diminishing (Zhao et al., 2017). It mentions that all other factors remaining constant, as the
consumption elevate, the level of marginal utility accomplished from every additional unit of the
commodity keeps falling and marginal utility might be lowering into negative utility since it
might become entirely unsuitable for consumers for consuming one more unit of the product.
e. Income and Substitution Effects
Two mist significant effects determined in microeconomics are the income effect and the
substitution effect. As stated by Dufourt et al. (2015), income effect could be referred to as the
change that takes place within the demand for any commodity or service that is caused through
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any change in the purchasing power of the consumer, which has resulted from the changes within
the company’s real income. This change could be the outcome of the rise that is taking place in
the wages or any other factor that affects the consumer or due to the existent income being freed
up through decline or elevation in the price of any commodity on which money is being spent.
On the other hand, one could be referring to the substitution effect as the decrease taking place in
the sales of a product that a company manufactures, which could be attributed to consumers who
are switching to other cheaper alternatives when the price elevates (Chan and Gillingham, 2015).
This effect is in general negative in nature for the sellers but beneficial for the buyers since they
would be availing a low priced commodity by switching from a high priced one. Substitution
effect is not only confined to the consumer goods but also manifest in several other areas as well,
for example, the demands existent for capital and labour.
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2. Explain ‘Behavioural Economics’ and critically evaluate the reasons behind irrational
behaviours of consumers.
One of the most significant topics of discussion related to both economics and psychology is
behavioural economics. As stated by Kanev and Terziev (2017), one can be referring to
behavioural economics as the incorporation of the study of psychology within the analysis done
for making decisions behind any economic outcome, for example, the factors that lead up to any
consumer purchasing one commodity in place of another. It conducts an evaluation over the
effects of cognitive, emotional, social, cultural and psychological factors, which lead an effect
over economic decisions that institutions and individuals make, and how such decisions are
different from the decisions that are implied by the classical theory (Kao and Velupillai, 2015). It
is fundamentally concerned with the bounds of consistency of the economic agents and includes
the evaluation of how market decisions are made along with the mechanisms, which drive the
choice made by public.
The behavioural economics has emerged as the backdrop of the approaches in traditional
economics, which is termed as the rational choice model (Drummond and Hodgson, 2016). It
provides a framework via which an understanding could be developed on how and when errors
are made by people. Systematic biases or errors recur in a predictable manner within specific
circumstances. The factors or lessons, which are extended from the behavioural economics could
be utilised so that environments can be created via people could be nudge towards healthier lives
as well as wiser decisions.
Based on the classical theory of economics, individuals behave in a rational manner. However, in
real world, the behaviour of individuals is irrational by nature. Traditional economics has put
forward a number of factors because of which consumer behaviour is irrational in nature. The
following are the few common reasons because of which irrational consumer behaviours can be
found out-
 Cognitive bias - One can refer to cognitive bias as the systematic errors that occur in the
thinking of consumers lead to an effect over the judgments and decision that people they
make. Most consumers make irrational and there are errors in their decisions since are
cognitively biased and based upon unrealistic assumptions.
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 Herding effect - The herding effect refers to following the “wisdom of the crowds” by
consumers. Because of this effect, consumers in the marketplace make their decisions
through the medium of the wisdom or the trends that majority of the consumers in the
marketplace are following.
 Discrimination - There are varying sorts of reasons because of which people or
consumers in the marketplace dislike, a certain commodity or the company that is
offering it or even the marketing strategies that is being used for marketing the
commodity. Most of these discriminations are illogical and lead to the occurrence of
irrational consumer behaviour.
 Lack of control - In various cases, a consumer does not have sufficient power to control
on their purchasing behaviour and often end up spending or consuming more than want
they want to spend and more than what they need. They purchase this lack of control over
consumption and purchase leads to the irrational behaviour of consumers within the
marketplace since they purchase more volume of goods and services, even when they
were not supposed to purchase them.
 Present bias - This factor is about consumers within the marketplace placing
comparatively higher value over consumption in the current moment. They fail in
considering the importance of their consumption in the future years and lead to excessive
consumption in the current scenario. Such a factor also leads to the increase in the
irrational behaviour of the consumers within a marketplace.
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Reference list
Chan, N.W. and Gillingham, K., 2015. The microeconomic theory of the rebound effect and its
welfare implications. Journal of the Association of Environmental and Resource
Economists, 2(1), pp.133-159.
Drummond, H. and Hodgson, J., 2016. Escalation in decision-making: Behavioural economics in
business. Routledge.
Dufourt, F., Nishimura, K. and Venditti, A., 2015. Indeterminacy and sunspots in two-sector
RBC models with generalized no-income-effect preferences. Journal of Economic Theory, 157,
pp.1056-1080.
Guo, Z. and Chen, J., 2018. Multigeneration Product Diffusion in the Presence of Strategic
Consumers. Information Systems Research, 29(1), pp.206-224.
Kanev, D. and Terziev, V., 2017. Behavioural economics: development, condition and
perspectives. Business Economics, 4(52), pp.387-410.
Kao, Y.F. and Velupillai, K.V., 2015. Behavioural economics: Classical and modern. The
European Journal of the History of Economic Thought, 22(2), pp.236-271.
Khan, A., Javaid, N. and Khan, M.I., 2018. Time and device based priority induced comfort
management in smart home within the consumer budget limitation. Sustainable cities and
society, 41, pp.538-555.
Liu, C.X. and Lv, N., 2018, November. A Study on the Substitution Efficiency of Agricultural
Mechanization Development in Zhejiang Province on Agricultural Labor Force. In 2018
International Conference on Economics, Business, Management and Corporate Social
Responsibility (EBMCSR 2018). Atlantis Press.
Monnot, M.J., 2017. Marginal utility and economic development: Intrinsic versus extrinsic
aspirations and subjective well-being among Chinese employees. Social Indicators
Research, 132(1), pp.155-185.
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Oliveira-Castro, J.M., Cavalcanti, P.R. and Foxall, G.R., 2015. What do consumers
maximize?. The Routledge Companion to Consumer Behavior Analysis, p.202.
Ouellette, P. and Vigeant, S., 2016. From partial derivatives of DEA frontiers to marginal
products, marginal rates of substitution, and returns to scale. European Journal of Operational
Research, 253(3), pp.880-887.
Zhao, Q., Zhang, Y., Zhang, Y. and Friedman, D., 2017, February. Multi-product utility
maximization for economic recommendation. In Proceedings of the Tenth ACM International
Conference on Web Search and Data Mining (pp. 435-443). ACM.
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