North South University

Group Project Submission

Managerial Economics
BUS 525.5
Spring 2019
Date of Submission: 29th April, 2019

Submitted To:
Dr. K.M. Zahidul Islam
Professor
School of Business and Economics, NSU

Prepared By:

Name ID

Fatema Tuz Zohora 1725074660

Humayra Sharif 1521538660

Lamiya Yousuf 1815227660

Sultana Ashrafi 1835068060

Md. Asif Zaman 1835173660

 Acknowledgement

First and foremost, we would like to that Allah for helping us to complete this report. The
success and final outcome of this project required a lot of guidance and assistance from many
people and we are extremely privileged to have got this all along the completion of our project.
All that we have done is only due to such supervision and assistance and we would not forget to
thank them.
We respect and thank our honorable faculty Dr. K.M. Zahidul Islam, for providing us an
opportunity to do the project while giving us all support and guidance which made us complete it
duly. We are extremely thankful to him for providing such a nice support and guidance endless
patience and continuous encouragement.
Last but not the least, this report would not have been possible without support from the group
members. We would like to thank our friends and family members for their support and
encouragement. Finally, we would like to express our sincere gratitude to those who provided us
with great support and encouragement to prepare the report on due time.
 Letter of Transmittal

29 April, 2019
Dr. K.M. Zahidul Islam
Professor
School of Business and Economics, MBA Program
North South University
Subject: Submission of the report on ―An Overview of Consumer Behavior: Theories and
Applications‖.

Dear Sir,
With due respect to our honorable faculty member, we prepared a report on ―An overview of
consumer behavior: Theories and applications‖ according to your instructions on due time. We
firmly believe that the knowledge and experiences we gathered upon the completion of the report
will helpful in our academic and professional life.
We are thankful to you for giving us such an opportunity to gain knowledge from the project. If
you have any further query regarding this internship report, we are obliged to provide all
necessary information you need.
We earnestly hope our work matched the fulfillment of the project.

Sincerely,
Fatema Tuz Zohora
Humayra Sharif
Lamiya Yousuf
Sultana Ashrafi
Md. Asif Zaman
An Overview of Consumer Behavior:
Theories & Applications
 Table of Contents

Chapter Topic Pages

1 Basics of Consumer Behaviour 1-3
2 Utility Maximization 4-8
3 IC Curves 9-11
4 Budget Constraints 12-13
5 Application and Mathematical Problems 14-18
-- Conclusion 19
 Executive Summary

Consumer behavior has a direct role in both the business and our day to day lives. It is equally
important in the study of Economics and Marketing. Our concern is the importance of consumer
behavior in the study of Microeconomics. This work basically denotes the implications and
applications of consumer behavior in terms of some basic theories and assumptions. Chapter 1
discusses the basics of consumer behavior, why it is important, what is its significance for a
business manager and for a marketer, what are its effects on the buying habits of the customers
etc. In chapter 2 we have theories of utility and utility maximization and some real life problems
that can be solved using those theories. Chapter 3 covers the basics of IC curves, how to handle
them, what are their significances and how to develop IC maps. Analysing budget constraints
and their impacts on buying behavior is the prime target of chapter 4. Finally in the last chapter
there are some more mathematical problems based on the above mentioned topics for better
understanding.
 Chapter 1
Basics of Consumer Behavior

What is consumer behavior?

Consumer behavior is the knowledge or study of how an individual customer behaves when
he/she select and buy a product to satisfy his/her needs. It basically refers to the actions and
reactions of customers about a product in the market place.
According to Louden and Bitta, ‗Consumer behavior is the decision process and physical activity
which individuals engage in when evaluating, acquiring, using or disposing of goods and
services.
According to Engel, Blackwell, and Mansard, ‗Consumer behavior is the actions and decision
processes of people who purchase goods and services for personal consumption.‘
Overall, consumer behavior is the perceived behavior of an individual about goods and services
and the decisions they take to maximize their satisfaction of that specified good or service.

Why it is important?
An organization makes a product for target group or customers. But if the organization do not
even know what the target group or customers like, how could the organization make profit out
of it? So, to make profit and to make customers satisfied about their products, it is very important
to know the customers and know their behavior in the market places. Otherwise, any
organization will face losses.

Importance of consumer behavior to business managers

The study of consumer behavior helps business manager in the following way:
 To innovate and design a product that will make consumers satisfied and fulfill their
wants and demands.
 To decide the right market place which is easily accessible for consumers.
 To decide the best price that will attract the target group to buy that product.
 To understand what factors influence the markets and consumers in buying decisions and
how those factors influence the whole situation.
 To know the best promotion method that will catch the eyes of customers and make them
interested on that product or service.

Importance of consumer behavior to marketers

Marketers‘ basic job is to sell their products and services to the customers. To retain this sell and
to make profit, it is necessary for every marketer to understand his/ her target customers and how
those customers behave about that specific product or service. Consumer behavior helps
marketers in the following way:

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  To know about the customers‘ likes and dislikes
 To understand customers‘ buying decision.
 To understand what factors can influence customer‘s buying decision
 To retain sells and profit
 To maintain existing customers and to create new customer
 To focus on the right market strategy.

Steps of consumer behavior

The consumers while buying a product goes through many steps. The study of consumer
behavior helps to understand how a consumer‘s buying decision is made and how they look for
and choose a product.
Consumer behavior has basically three distinct steps:
1. Consumer preference: It describes the reasons behind why people might prefer one good
to another.
2. Budget constraints: It assumes that consumers always have limited incomes which
restricts the quantities of good they can buy.
3. Consumer choices: With their preferences and limited income, consumers try to buy
combinations of goods and services that maximizes their satisfaction and benefits.
These are the basic steps of consumer behavior theory. Because consumer always have multiple
preferences but for their limited budget, they choose the combination of products that maximize
their satisfaction with this limited income. So it is very important for marketers, sales persons,
business managers to know about these three basic steps to take any decision regard to make
product price.

What is consumer preference and some assumption?

Consumer preference refers to the reasons why consumer prefer one good to another and how it
results in an optimal choice. Consumer preferences helps a consumer to categorize and rank
different bundles of goods according to levels of utility.

Some basic assumptions about consumer preference

The theory of consumer behavior describes three basic assumptions about how people prefer one
market basket to another. These assumptions are as following:
Completeness: which is when the consumer does not have indifference between two goods. For
example Pamel has two alternative choices: Mango or Apple. The assumption of completeness
reflects the idea that Pamel should be able to compare his options. In other words, Pamel can be
able to say whether he likes mango or apple better.
Transitivity: which tries to define a relationship between different goods. Suppose, a consumer
prefers good A to good B and prefers good B to good C, then the consumer should prefer good A
to good C. For example, Pamel prefers mango (good A) to apple (good B) and prefers apple
(good B) to orange (good C). Then Pamel should prefer mango (good A) to orange (good C).
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More is better than less: this assumption is based on non-satiation, which states that more of a
good is always better as long as it does not affect the consumer‘s ability to utilize all other goods.
Pamel would be happy with 5 mango and 2 apple, than 3 mango and 1 apple. Pamel has no point
of satiation or the ability to be satisfied, some economists call this assumption consumer greed.

What is consumer choice?

Consumer choice is defined as the decisions that consumers take with regard to goods and
services. The theory of consumer choice assumes consumers wish to maximize their utility or
satisfaction through the optimal combination of goods or services with their limited budget.

Consumer equilibrium-equimarginal principle

Consumer equilibrium occurs when the marginal utility/price of each good is the same. This
combination of goods ensures that they maximize their total utility. This is also called utility-
maximizing choice.

Pizza ( $3 each) Burger ($2 each)

Quantity Marginal Marginal Quantity Marginal Marginal
Utility Utility Per Utility Utility Per
dollar dollar
A 1 70 23.33 2 60 30
B 2 60 20 4 40 20
C 3 40 13.33 5 30 15

Here B is maximizing his/her utility through the best combination of pizza and burger with
his/her limited budget.
The theory of consumer behavior rests in the assumption that people behave rationally in an
attempt to maximize the satisfaction that they can obtain by purchasing a particular combination
of goods and services. So to better understand the market, marketers must consider consumer
preferences, budget, choice and overall consumer behaviors on that particular product of
marketers.

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 Chapter 2
Utility & Utility Maximization

Utility
Utility was first introduced in 18th century by Swiss mathematician Daniel Bernoulli. He
referred it to the total satisfaction received from consuming a good or service.

Total utility
Total Utility is the utility from all units of consumption. According to Mayers—‖Total Utility is
the sum of the marginal utilities associated with the consumption of the successive units.
Suppose, a man consumes five breads at a time. He derives from first bread 20 units of
satisfaction from 16, from third 12, from fourth 8 and from fifth 4 i.e., total 60 units. Generally
total utility will not be zero or negative. Whenever there are any amount of satisfaction from the
product, there has to be some positive value for total utility.

Marginal Utility
Marginal utility is the utility derived from the last or marginal unit of consumption. It refers to
the additional utility derived from an extra unit of the given commodity purchased, acquired or
consumed by the consumer. This can be zero or negative as expressed in the below figure.

2
0

1
6

1
2 7

4
Utility Maximization
The prime target of a consumer is to get maximum level of satisfaction from a product or group
of products. So utility maximization process guaranties the best value for money from the
customers‘ or consumers‘ point of view. From the theory of micro economics we know that the
condition for utility to be maximum is

MUx / MUy = Px / Py

Where MUx = Marginal Utility for a product X

MUy = Marginal Utility for a product X

Px = Price of a product X

Py = Price of a product X

Following mathematical problems can be used for better understanding of utility and utility
maximization.

Problem 1) From the below tables decide the combination of Pizza and Pepsi that will give you
the maximum satisfaction. Price of Pepsi is $1, Price of Pizza is $2

Pizza Pepsi

Q TU Q TU

4 115 5 63

5 135 6 75

6 154 7 86

7 171 8 96

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Solution:

Let Pizza= X and Pepsi= Y

Using the following tables we have found the marginal utilities individually.

Pizza Pepsi

Q TU MU Q TU MU

4 115 ------ 5 115 ------

5 135 20 6 135 12

6 154 19 7 154 11

7 171 17 8 171 10

We can see that for Q=5, MUx = 20, Px= 2 and Q=8, MUy= 10, Py=1

MUx / MUy = Px / Py = 10

Therefore utility will be maximum. So the customer should buy 5 units of Pizza and 8 units of
Pepsi.

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Problem 2) A decision maker wishes to maximize the total benefit associated with three activities
X, Y, Z. The price of per unit of activities of X, Y and Z are $1, $2, $3 respectively.

Level of MBx / Px MBy / Py MBz / Pz

activity

1 10 22 14

2 9 18 12

3 8 12 10

4 7 10 9

5 6 6 8

6 5 4 6

7 4 2 4

8 3 1 2

a) Suppose the decision maker can spend a total of only $18 on the three activities.
What is the optimal level of X, Y, and Z? Why is this combination optimal? Why is
the combination 2X, 2Y, and 4Z not optimal?
b) Now suppose the decision maker has $33 to spend on the three activities. What is
the optimal level of X, Y, and Z?

Solution:
a) From the table we find that for X=1, Y=4, and Z= 3

MBx / Px = MBy / Py = MBz / Pz = 10

And 1X + 4Y + 3Z= 1*1 + 4*2 + 3*3 = 18 which is equal to our budget, We can take the
combination (1X, 4Y, 3Z) as an utility maximization point since

MBx / Px = MBy / Py = MBz / Pz

For 2X, 2Y, 4Z

MBx / Px = MBz / Pz = 9 But, MBy / Py = 18.

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Therefore, although the combination falls within our budget we cannot take it as the optimum
point since the ratios are not equal.

b) Now the new budget is $33. So surely the consumer can increase the level of activities.

From the table we find that for X=5, Y=5, and Z= 6

MBx / Px = MBy / Py = MBz / Pz = 6

And 5X + 5Y + 6Z= 5*1 + 5*2 + 6*3 = $33 which is equal to our budget, We can take the
combination (5X, 5Y, 6Z) as an utility maximization point since

MBx / Px = MBy / Py = MBz / Pz

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 Chapter 3
Indifference Curve

An indifference curve is a chart appearing of two products that give the customer equivalent
fulfillment and utility. Each point on a lack of indifference curve shows that a buyer is apathetic
between the two and all focuses give him a similar utility.

In financial aspects, an indifference curve associates focuses on a chart speaking to various

amounts of two products, focuses between which a customer is indifference. That is, the buyer
has no inclination for one group of products or heap of products over an alternate mix on a
similar group of products. One can likewise allude to each point on the indifference curve as
rendering a similar dimension of utility (fulfillment) for the purchaser. As it were, an
indifference curve is the locus of different focuses demonstrating distinctive blends of two
merchandise giving equivalent utility to the customer. Utility is then a gadget to speak to
inclinations as opposed to something from which inclinations come. The principle utilization of
an indifference curve is in the portrayal of conceivably recognizable interest designs for
individual purchasers over item packages.

History: The hypothesis of an indifference curve was invented by Francis Ysidro Edgeworth,
who clarified in his 1881 book the arithmetic required for their illustration. Later on, Vilfredo
Pareto was the principal writer to really draw these bends, in his 1906 book. The hypothesis can
be gotten from William Stanley Jevons' ordinal utility hypothesis, which sets that people can
generally rank any utilization packages by request of inclination.

The beginning stage for lack of interest examination is to distinguish conceivable crates of
products and ventures which yield a similar utility (convenience, or fulfillment) to customers. It
is accepted that people, looked with a spending imperative, will pick the crate that amplifies their
absolute utility – as it were, they will act sanely while assigning their financial limit. The pursuit
to recognize groups of merchandise and ventures that yielded a similar utility denoted a
noteworthy point in the improvement of buyer hypothesis as detachment examination does not

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require the immediate estimation of utility for a solitary decent. Lack of concern examination, in
this way, gave an answer for the long-standing issue of how to gauge utility.

Characteristics of indifference curve: The indifference curve have various traits and
fascinating properties which have come to be known as trademark highlights or properties of
indifference curve. Coming up next are a portion of the significant highlights.
a) An IC slopes downwards to the right: This incline connotes that when the amount of one
item in group is expanded, the measure of the other were lessens. This is fundamental for the
dimension of fulfillment to continue as before on an apathy bend.
b) Indifference curves are convex to the origin: The significant element of the
indifference curve is that they are arched to the source and they can't be inward to the cause. A
typical indifference curve will be convex to the origin and it can't be concave. Just convex curves
will loan to the standards of Diminishing Marginal Rate of substitution. On account of concave
curve, it will prompt expanding minor rate of substitution which is unthinkable. So as to
comprehend this all the more unmistakably we need to think about the accurate indicate and
importance in going starting with one point then onto the next on an indifference curve which is
raised to the cause.
c) Indifference curves never intersect each other: Two ICs will never meet one another.
Additionally, they need not be parallel to one another either. the indifference curve can't intersect
one another. It is because of tangent point, the higher curve will give as much as of the two items
as is given by the lower indifference curve. This is crazy and impossible.
d) A higher indifference curve represents a higher level of satisfaction than a lower
indifference curve: A higher IC shows a larger amount of fulfillment when contrasted with a
lower IC. A higher IC implies that a customer favors a bigger number of merchandise than
not.The last property of indifference curve is that a higher indifference curve will speak to a
larger amount of fulfillment than a lower indifference curve. At the end of the day, the mixes
which lie on a higher indifference curve will be wanted to the mixes which lie on a lower
indifference curve.

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Indifference Map
An Indifference Map is a lot of Indifference Curves. It portrays the total image of a shopper's
inclinations. We realize that a customer is unconcerned among the mixes lying on a similar
indifference curve. Nonetheless, note that he inclines toward the mixes on the higher lack of
indifference curves to those on the lower ones. This is on the grounds that a higher indifference
curve suggests a more elevated amount of fulfillment. Along these lines, all mixes on IC1 offer a
similar fulfillment, however all mixes on IC2 give more noteworthy fulfillment than those on
IC1.

Marginal Rate of Substitution

In financial aspects, the marginal rate of substitution (MRS) is the measure of a decent that a
customer is eager to surrender for another good, as long as the new good is similarly fulfilling.
It's utilized in indifference hypothesis to break down purchaser conduct. The marginal rate of
substitution is determined between two merchandise set on an indifference curve, showing a
boondocks of equivalent utility for every mix of "good A" and "good B."

Limitations of Marginal Rate of Substitution: The marginal rate of substitution does not look
at a combination of merchandise that a buyer would incline toward pretty much than another mix
yet inspects which mixes of products the customer would favor the same amount of. It
additionally does not analyze minimal utility – how much better or more regrettable off a
customer would be with one mix of products as opposed to another – in light of the fact that all
combination of merchandise along the indifference curve are esteemed the equivalent by the
purchaser.

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 Chapter 4
Budget Line

The Budget Line also called as Budget Constraint shows all the combinations of two supplies
that a consumer can afford at given market prices and within the particular income level.

We know that the higher indifference curve is the utility and thus utility maximizing consumer
will try to reach the highest possible indifference curve. But limited income and given the market
price of goods and services. The income in hand is the main constraint that decides how high a
consumer can go on the indifference map. In a two product model the financial constraint can be
expressed in the form of the budget equation:

Px . Qx + Py . Qy =M

Where

Px and Py are the prices of product X and Y and Qx and Qy is their respective quantities.

M= consumer‘s money income

The Budget equation states that the consumer‘s spending on product X and Y cannot exceed his
money income (M). Thus the quantities of produces X and Y that a consumer can buy from his
income (M) at given prices Px and Py can be calculated through the budget equation given below:

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The values of Qx and Qy are plotted on the X and Y axis and a line with a negative slope is
drawn connecting the points so obtained. This line is called the budget line.

Importance of Budget Line: Since budget line allows you to create a spending plan for money
it ensure that always have enough money for the things company need and the things that are
important to company. Following a budget or spending plan will also keep out of debt or help
work way out of debt if currently in debt.

Budget Line Downward Sloping

The budget line is downward because in order to increase the consumption of one good the
consumption of other good must be reduced with constant M.

Budget Line is Straight

Slope of a budget line is the "price ratio" of the two goods. For example we have two goods - X
& Y. The price of the two goods be Px and Py respectively. The price ratio is Px/Py and the
slope of the line = -(Px/Py). We work under the belief that prices of both goods are constant and
are independent of quantity. Under these assumptions the slope of the budget line will remain
constant over all permissible values of X and Y. Since the slope is constant we will get a straight
line.
Example
Suppose meat costs $4 per pound and potatoes $2 per pound. Draw her budget constraint.
Let M= meat and P= potatoes. Connie‘s budget constraint is
4M + 2P =200
or
M=50-0.5P.
As shown in the graph below, with M on the vertical axis, the vertical intercept is 50 pounds of
meat. The horizontal intercept may be found by setting M=0 and solving for P. The horizontal
intercept is therefore 100 pounds of potatoes.

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 Chapter 5
Applications of Consumer Behavior & Mathematical Analysis

We can use the theories of consumer behavior to solve real life problems associated with
utilities, market bundles, utility maximization, Budget lines, Indifference Curves etc. Here are
included some of the problems that can be solved using the theories included in the previous
chapters.
This part goes over how to solve a variety of questions focusing on budget constraints and how
to manipulate them.

Problem 1:
Answer the following questions based on the table. A consumer is able to consume the following
bundles of rice and beans when the price of rice is $2 and the price of beans is $3.

Rice Beans

12 0

6 4

0 8

a) How much is this consumer's income?

b) Draw a budget constraint given this information. Label it B.
c) Construct a new budget constraint showing the change if the price of rice falls $1. Label
this C.
d) Given the original prices for rice ($2) and beans ($3), construct a new budget constraint if
this consumer's income increased to $48. Label this D.

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Solution:
a) In order to find out the income we can just multiply the quantity of each goods with the
corresponding prices. The income should be same for each of the combinations. So if we just
calculate we find:
12*2 + 0 (No Beans) = $24
6*2 + 4*3 = $24
0 (No Rice) + 8*3 = $24
In each cases we find $24. So we can safely say that the income or budget constraint of the
consumer will be $24.

b) To draw the budget constraint we take rice on the X axis and Beans on the Y axis.
Putting the points (12,0), (6,4) and (0,8) on the graph and connecting them we get the budget
constraint. According to our theory it is a downward sloping straight line. So we got that right.
Point (12,0) means that all budget was spent on Rice and no money for Beans. Similarly point
(0,8) means all money for Beans and no money for Rice.

c) Now new price for rice is $1. Therefore the new level of maximum amount of rice that can be
bought will be 24/1= $24. So we can buy more rice, which makes perfect sense as the price has
fallen. However, there will be no change in the Bean‘s maximum level as its price is unchanged.
That is why there will be no shift in the budget line but it will rotate.

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d) This part demands the new position of the budget line when the income of the consumer has
changed. With our common sense we can say that a change in the income will surely have an
effect on the amount of good consumed. If income rises, the consumer will be able to enjoy more
amount of both beans and rice so budget line will shift right. On the other hand if income
decreases he will be bound to sacrifice both of the goods so the constraint will shift to left.
When budget is $48, price of rice is $2, we can buy 48/2= 24 units of rice if we pay all our
budget for rice. Similarly we can buy 48/3= 16 units of beans if we pay everything for beans.
Considering the points (24,0) and (0,16) we draw our new budget line accordingly.

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Problem 2:
Draw indifference curves that represent the following individuals‘ preferences for hamburgers
and soft drinks. Indicate the direction in which the individuals‘ satisfaction (or utility) is
increasing.
a) Joe has convex preferences and dislikes both hamburgers and soft drinks.
Joe dislikes both goods. So we can say that he prefers less more, different from what we have
learned in the usual scenarios (more to less). So his curves will be convex to the origin. Also it is
convex because he is indifferent in the two goods, meaning he dislikes each of them equally.

b) Jane loves hamburgers and dislikes soft drinks. If she is served a soft drink, she will
pour it down the drain rather than drink it.
Jane‘s dislike towards the drinks means she does not want any of it. So we can assume it to be a
neutral good for her. So her curve will be parallel to the axis of Soft Drinks and level of
satisfaction will be in the upward direction where there are Hamburgers.

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c) Bob loves hamburgers and dislikes soft drinks. If he is served a soft drink, he will drink
it to be polite.
Bob will not pour down if he is served a soft drink like the above case. So he may consume soft
drink upto a specific level, but from then his disliking for soft drink will increase. So, more
hamburgers and less soft drinks will give him more utility.

d) Molly loves hamburgers and soft drinks, but insists on consuming exactly one soft drink
for every two hamburgers that she eats.
This case can be considered a situation for two perfect complement products as she wants to
consume both of the products at a fixed proportion. So her curves will be L-shaped.

e) Mary always gets twice as much satisfaction from an extra hamburger as she does from
an extra soft drink.
This is an example for two perfectly substitute products as she gets equal satisfaction from either
1 hamburger or 2 soft drinks. So her curves will be downward sloping straight lines..

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 Conclusion

Across the different problems we have seen how study of consumer behaviour can be an
effective tool to analyse consumers‘ response to a particular product or a group or combination
of products. Any company recognizing these issues and acting accordingly can come up with
success in terms of business and profitability. On the other hand, in order to ensure the best use
of the consumers‘ income or budget, study of consumer behaviour is a mandatory. In the
chapters we have included the essentials of consumer behaviour in an uncomplicated manner so
that anyone can easily have a grasp of these subjects and use the theories to solve problems
related with utilities, budget lines, IC curves etc. that someone might encounter in day to day life.

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 References

1) Pindyck, R. S., & Rubinfeld, D. L. (2009). Microeconomics. Upper Saddle River, N.J:
Pearson/Prentice Hall.
2) Loudon, D. D. (1984). The buying behaviour is the decision process and physical activity
which the individuals engage in evaluating, acquiring, using or disposing of goods and services.
Individual in Society, 383.
3) V. Vijaya lakshmi, D. N. (2017). Impact of Gender on Consumer Purchasing Behaviour.
IOSR Journal of Business and Management (IOSR-JBM), 19(8), 33-36.
4) https://www.investopedia.com/terms/i/indifferencecurve.asp
5) https://businessjargons.com/budget-line.html
6) https://www.cengage.com/resource_uploads/downloads/1426648359_171999.pdf

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