consumer behavior and demand Flashcards
rational decision making, demand curve, elasticity of demand
assumption of rationality (firms, consumers, workers, governments.)
1) Firms aim for profit maximization to maximize returns to shareholders.
2) Consumers aim to maximize their utility
for satisfaction
3) workers aim to maximize their welfare at work
4) governments aim to want to maximize the welfare of citizens
reasons why consumers may not aim to maximize utility (5)
- the influence of other people (herding)
- habitual behavior
- inertia (people may be lazy so they do nth)
- poor computational skills to see which prices are better
- framing and bias
reasons why firms may not aim to maximize utility (4)
- Non-profit motives, like environmental sustainability
- Risk aversion
- principle-agent problem
- knowledge limitations
use of demand curve
shows effective demand
relationship btwn price and demand / law of demand
relationship btwn price and demand is inverse
how does income effect cause movement along demand curve
when prices are higher -> lower purchasing power of money -> cant afford more goods
how does substitution effect cause movement along demand curve
when prices increase -> substitutes become more price competitive -> people switch
movement vs shift along demand curve
movement - price
shift - all other factors
factors affecting demand curve (PASIFIC)
population
advertising
substitute price
income (consider normal or inferior)
fashion and tastes
interest rates
complements price
effect of income change with normal goods
when income goes up, demand will shift right
effect of income change with inferior goods
when income go up, demand decrease, shift left.
effect of interest rates and demand curve
if interest lower, people can borrow more, buy more, increased demand
diminishing marginal utility effect in demand curve
- As the marginal utility of a good decreases with each additional unit consumed, individuals are willing to pay less for each subsequent unit.
how does the downward slope of the demand curve show diminishing marginal utility
- downward slope reflects the inverse relationship between price and quantity demanded, driven by the diminishing marginal utility of the good.
numerical value of perfectly inelastic demand
PED 0
numerical value of inelastic demand
PED btwn 0 and 1
numerical value of unitary demand
PED 1
numerical value of elastic demand
PED btwn 1 and infinity
numerical value of perfectly elastic demand
PED infinity
factors influencing PED (7)
availability of substitutes
brand loyalty
width of market definition
time
percentage of total expenditure
addictiveness
durability
effect on PED (availability of sub)
: The large number of substitute product ⇒ Elastic PED
: The lack of substitute product ⇒ Inelastic PED
effect on PED (time)
In the short run and peak time ⇒ Inelastic PED
: In the long run and off peak time ⇒ Elastic PED
effect on PED (width of market definition)
more defined, like pasta - elastic
less defined, like food - inelastic
effect on PED (proportion of income spent)
The large proportion of income spent on the product ⇒ Elastic PED
: The small proportion of income spent on the product ⇒ Inelastic PED
why are durable goods typically price inelastic? (2)
- they typically dont have many substitutes
- since they are long term investments, people are willing to pay more now to not pay later
what type of goods are price elastic?
luxury goods as they are discretionary purchases
what type of goods are price inelastic?
necessities
PED elastic and total revenue
when price is higher, demand decreases by a larger proportion, total revenue decreases and vice versa
PED inelastic and total revenue
when price increases, demand decreases by a small proportion, total revenue increases
PED unitary and total revenue
when price increases, demand increases by a small proportion, total revenue does not change
limitations of PED (2)
consumers dont always act rationally
value of PED changes over time
numerical value of luxury goods
YED > 1
numerical value of necessities
0 <YED < 1 or
YED = 0
what does YED tell us?
if a good is normal or inferior
how to know a good is normal
is YED is positive
how to know a good is inferior
if YED is negative
elasticity of normal goods (both more than and less than)
more than 1 = income elastic = luxury normal
less than one = income inelastic = necessary
YED = 0?
perfectly income inelastic, no relationship
elasticity of inferior goods (both more than and less than)
more than 1 = income elastic
less than 1 = income inelastic
what is income inelastic inferior good
goods are still considered inferior because demand decreases as income rises, but the decrease in demand is proportionally less than the increase in income.
How businesses can use knowledge of YED ? (2)
- Firms can predict sales and adjust production scale.
- Firms can know which products will perform best given the time
disadvantage of >1 being luxury/superior goods and <1 being basic goods
a group of products may be considered basic goods but not every product in the group is necessary.
how do you understand two goods are substitutes or complimentary
substitute XED +
complimentary XED -
numerical value of two goods having price elastic demand (XED)
less than 1
what is the relationship between two goods with XED less than 1
price elastic demand = very strongly related
numerical value of two goods having price inelastic demand (XED)
more than one
what is the relationship between two goods with XED more than 1
price inelastic demand = weakly related
numerical value of two goods having price perfectly inelastic demand (XED)
0
what is the relationship between two goods with XED 0
nothing
Factors That Influence YED
YED is influenced by any factors in an economy which change the wages of workers (bring up the economic cycle, recession and all) (also tax changes and min wage)
Significance of Elasticities to Firms (1)
to set optimal prices that maximize profits. (decision on if they shld raise or lower prices, similar to total revenue and elasticity relationship)
significance of cross elasticity of firms
how price of substitute products affects demand for their own product allows firms to develop competitive strategies. might adjust pricing if a close substitute experiences a price change.
Significance of Elasticities to consumers
can leverage elasticity concepts to make smarter purchasing decisions. (depending on the elasticity they can switch if possible and plan budget)
Significance of Elasticities to government
government policies aimed at influencing economic activity and consumer welfare.
how does elasticity effect taxation
determine the impact of taxes on consumption and potentially choose products with inelastic demand for taxation to minimize consumer resistance.
how does elasticity effect subsidies
allows governments to target subsidies for essential goods that are income elastic, particularly for low-income groups.
how does elasticity effect market regulation
Cross elasticity helps assess the impact of regulations on related markets. For example, restricting a good might unintentionally increase demand for substitutes.
