Consumer Behavior Principles by Mankiw

From shaving face in the morning to brushing our teeth before sleep, we experience consumer behavior for every product that we use. Mankiw gives four principles to explain how people make decisions in his famous textbook, “Principles of Microeconomics” He defines economy, “An economy is just a group of people interacting with one another as they  go about their lives.” His four principles to describe consumer behavior are:

1-    Trade-off

2-    Opportunity Cost

3-    Marginal Changes

4-    Incentives

Principle 1: Trade-Offs and and Consumer Behavior

Prof. Mukul Asher used to say that every free thing entails a lot of cost at the end of the day. Mankiw mentions the famous adage, “There is no such thing as a free lunch.”

In fact, whatever you receive, you have to pay in one way or the other. For example, you visit this website to improve your knowledge or to add into the understanding of other visitors you are trading off your time which you could have spent on some game or porn site for some different kind of satisfaction. On the other hand, if you visit porn sites by leaving this information, you are trading off on the information which could have helped you in future.

Mankiw quotes the famous classic example of “Guns and butter” which just means if your country spends a lot on defense then you would be left with less for your butter. This is a case with nations having top six armies in the world.

Mankiw mentions that society has a trade-off between equity and efficiency. He defines efficiency as a maximum benefit which society gets from its scarce resources. He defines equity as a distribution of those benefits fairly among all members of the society. In a country like Pakistan or India, there are millions of people surviving below the poverty line. The political leadership is inclined to introduce subsidies on food, education and even housing. Such policies may be helpful for equity purposes but not efficient economic systems.

Politicians say that ‘economists don’t have hearts for the poor.’ The economists claim that politicians don’t have a sense for efficient economic policies. A mixture of the both comes in the shape of the political economy.

Principle 2: Opportunity Costs and Consumer Behavior

Sometimes, trade-offs and opportunity costs are confused. Mankiw distinguishes them both. When people go for trade-offs, they have to decide upon the expenses which they have to bear while going for an alternative. While going to our previous example, if you are leaving this website for some cheap game or porn site, there are certain opportunity costs involved which may not be evident.

You know whatever website you visit there are costs for computers, internet connection and your time. But there are some benefits or expenses which you have to earn/pay in future. You can learn the managerial economic principles here which can be helpful for your thinking. However, if you enjoy some cheap game, you get immediate satisfaction.

Mankiw says, “The opportunity cost of an item is what you give up to get that item.”

Principle 3: Marginal Benefits/Costs and Consumer Behavior

The main thought behind any business is ‘maximization of profits.’ If a business is in the continuous loss, it can be a charity but not a business. On the other hand, the main thought behind actions of a consumer is ‘maximization of satisfaction.’

Mankiw includes first two steps of Robert S. Pindyck and Daniel L. Rubinfeld to understand consumer behavior in this one principle named as, “Rational People Thinks at the Margin.” He says:

“You will encounter consumers who buy a bundle of goods and services to achieve the highest possible level of satisfaction, subject to their income and prices of those goods and services.”

Then he goes to marginal benefits and costs in words, “Economists use the term marginal changes to describe small increments to an existing plan of action. Keep in mind that limited means “edge” so marginal changes are adjustments around the edges of what you are doing. Rational people often make decisions by comparing marginal benefits and marginal costs.”

He quotes the classic question, “Water is a basic need for survival while diamonds are unnecessary. Then why water is so cheap, and diamonds are so expensive?” It is just the marginal benefit that every extra unit of the item provides. You are traveling through a desert without water for last ten hours. You would like to pay for a glass of water with a couple of diamonds. However, every glass of water reduces the marginal benefit and finally no immediate interest as water is available in plenty. But diamonds are expensive for their rarity and consumers to see the marginal benefit too high to own an extra piece of diamond.

Principle 4: People Respond to Incentives

Mankiw quotes, “People respond to incentives. The rest is commentary.”

Incentives include rewards and punishments. It is vital for business as well as public sector to utilize this powerful principle. A company can generate much more profits by offering incentives. A federal policymaker can introduce incentives to improve governance, to control corruption and negative externalities.

Singapore government decided to stop the use of Chew gum. Instead of framing laws to ban chew, they banned the sale of chew gums. Many countries have made smoking a costly act not only to reduce smoking but also to generate huge taxes.

Not only in managerial economics and microeconomics but also in public management, the careful use of incentives can be benefited.

The high prices of gasoline, costly option to own a car and excellent public service can lead people to use public transport in most of the cases which can result in less private vehicles on roads and less pollution. Less pollution may be transferred into a healthy environment, less cost on health and more money for the welfare of the people. 

Consumer Behavior Model Introduction

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