Welcome to Consumer Behaviour and Demand!

Ever wondered why you suddenly want a specific brand of trainers just because your favourite influencer wore them? Or why you keep buying that expensive coffee even when the price goes up? In this chapter, we are going to dive into the world of consumer behaviour. We’ll explore how we make choices, why we sometimes act "irrationally," and how businesses use the demand curve to understand our shopping habits. This is a core part of your "Markets in Action" section, so let’s get started!

1. Rational Decision Making

In traditional Economics, we often start with a big assumption: that everyone is rational.

What does "Rational" mean?
It means that consumers aim to maximise utility (which is just a fancy word for "satisfaction" or "happiness"). Every time you spend a dollar, a rational version of you asks, "Is this the absolute best way to get the most happiness for my money?" Similarly, firms (businesses) are assumed to be rational because they aim to maximise profits.

Why we aren't always rational

Don't worry if you find it hard to be "rational" when shopping—most people do! Real life is messy, and the syllabus identifies several reasons why we don't always maximise our utility:

  • The influence of other people's behaviour (Herding): This is the "follow the crowd" mentality. If everyone is buying a specific phone, you might buy it too, even if a cheaper one suits you better.
  • Habitual behaviour: We are creatures of habit. You might buy the same brand of cereal every week just because you’ve always done it, without checking if there’s a better deal.
  • Inertia: This is the tendency to do nothing. A classic example is staying with a bank or a mobile provider with high fees simply because it feels like too much effort to switch.
  • Poor computational skills: Sometimes, the math is just too hard! Shoppers often struggle to figure out which "Buy One Get One Free" deal is actually the best value.
  • The need to feel valued: Sometimes we buy things not for the item itself, but for the feeling of status or appreciation we get from the purchase.
  • Framing and bias: The way information is presented (the "frame") changes our choice. For example, a sign saying "90% Fat-Free" sounds much better than "10% Fat," even though they are the same thing!

Quick Review: Rationality assumes we always choose the "best" option to be happy. In reality, habits, emotions, and laziness (inertia) get in the way.

2. The Demand Curve

Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given time period. Remember: wanting something isn't enough; you must have the money to buy it for it to count as demand!

Diminishing Marginal Utility (DMU)

Why is the demand curve usually downward sloping? One reason is Diminishing Marginal Utility.
Imagine you are very thirsty and buy a cold soda. That first soda gives you huge satisfaction (utility). The second one is okay, but not as good as the first. By the fifth soda, you might feel sick!
As you consume more units, the extra (marginal) satisfaction you get from each extra unit falls. Because the satisfaction drops, you are only willing to buy more if the price falls.

Movements vs. Shifts

This is a very common area for mistakes! Let’s keep it simple:

  • Movement: A movement happens only when the Price of the good changes. If price goes up, we move up the curve (contraction). If price goes down, we move down the curve (expansion).
  • Shift: A shift happens when anything else (other than price) changes. The whole curve moves left (less demand) or right (more demand).

What causes a Shift in Demand?

Use the mnemonic PIRATES to remember these factors:

  • P - Population: More people (or a change in age distribution) means more demand.
  • I - Income: When real income rises, people have more to spend.
  • R - Related Goods:
    • Substitutes: If the price of Pepsi goes up, the demand for Coca-Cola shifts right.
    • Complements: If the price of gaming consoles goes up, the demand for games shifts left (because you need both together).
  • A - Advertising: Successful ads shift demand to the right.
  • T - Tastes and fashions: If something becomes trendy, demand shifts right.
  • S - Seasons: Demand for ice cream shifts right in the summer.

Key Takeaway: Price changes cause movements. Other factors (like income or trends) cause shifts.

3. Elasticities of Demand

Elasticity measures "responsiveness." If we change the price, how much will the quantity demanded react?

Price Elasticity of Demand (PED)

The formula for PED is:
\(PED = \frac{\% \Delta Quantity Demanded}{\% \Delta Price}\)
(Tip: Always put Quantity on top! "Q" comes before "P" in the alphabet.)

Interpreting the numbers:
  • Perfectly Inelastic (0): Price change has zero effect on quantity (e.g., life-saving medicine).
  • Inelastic (Between 0 and 1): The quantity doesn't react much. People are quite loyal or need the product.
  • Unitary Elastic (1): The percentage change in price and quantity is exactly the same.
  • Elastic (Greater than 1): Consumers are very sensitive to price. A small price rise leads to a big drop in sales.
  • Perfectly Elastic (\(\infty\)): At a specific price, demand is infinite, but if the price rises even a tiny bit, demand drops to zero.
Factors influencing PED:
  • Availability of substitutes: More substitutes = more elastic (easier to switch).
  • Branding: Stronger branding = more inelastic (people are loyal).
  • Percentage of income: Expensive things (like cars) are more elastic than cheap things (like salt).
  • Addictiveness: Addictive goods (like cigarettes) are very inelastic.
  • Durability: If a product lasts a long time, you might delay buying a new one if the price rises, making it more elastic.

PED and Total Revenue

Total Revenue (TR) is calculated as: \(TR = Price \times Quantity\).
Businesses use PED to decide whether to raise prices:

  • If demand is Inelastic: Raising the price will increase Total Revenue (because people keep buying it anyway).
  • If demand is Elastic: Raising the price will decrease Total Revenue (because everyone will stop buying it).

4. Income and Cross-Elasticity

Income Elasticity of Demand (YED)

This measures how demand reacts to a change in Income.
\(YED = \frac{\% \Delta Quantity Demanded}{\% \Delta Income}\)

  • Normal Goods (Positive YED): As you earn more, you buy more (e.g., eating at restaurants).
    • Income Elastic (>1): Luxury goods like designer handbags.
    • Income Inelastic (0 to 1): Necessities like milk.
  • Inferior Goods (Negative YED): As you earn more, you buy less because you switch to better alternatives (e.g., instant noodles or public bus travel).

Cross Elasticity of Demand (XED)

This measures how the demand for Good B reacts to a price change in Good A.
\(XED = \frac{\% \Delta Quantity Demanded of Good B}{\% \Delta Price of Good A}\)

  • Substitutes (Positive XED): If the price of Good A goes up, demand for Good B goes up (people switch).
  • Complements (Negative XED): If the price of Good A goes up, demand for Good B goes down (since you use them together).
  • Unrelated (0): A price change in pencils has no effect on the demand for cheese!

Did you know? Governments love to tax goods with Inelastic demand (like fuel or cigarettes). Why? Because they know that even with a tax (which raises the price), people will still buy them, guaranteeing lots of tax revenue!

Quick Summary Table for your Revision:
PED: Responsiveness to Price.
YED: Responsiveness to Income (Positive = Normal, Negative = Inferior).
XED: Responsiveness to other goods' prices (Positive = Substitutes, Negative = Complements).