By: Deepali Mandalia

Module II
By: Deepali Mandalia
Theory of Consumer Behavior

Useful for understanding the demand side of the market. Utility - amount of satisfaction derived from the consumption of a commodity .measurement units utils Utility concepts
cardinal utility - assumes that we can assign values for utility, (Jevons, Walras, and Marshall). E.g., derive 100 utils from eating a slice of pizza ordinal utility approach - does not assign values, instead works with a ranking of preferences. (Pareto, Hicks, Slutsky)
Total utility and marginal utility

Total utility (TU) - the overall level of satisfaction derived from consuming a good or service Marginal utility (MU) additional satisfaction that an individual derives from consuming an additional unit of a good or service.
TU MU Q
Total utility and marginal utility

Example : Q 0 1 2 3 4 TU 0 20 27 32 35 MU --20 7 5 3
5 6 7
35 34 30 36
0 -1 -4
TU, in general, increases with Q At some point, TU can start falling with Q (see Q = 6) If TU is increasing, MU > 0 From Q = 1 onwards, MU is declining principle of diminishing marginal utility As more and more of a good are consumed, the process of consumption will (at some point) yield smaller and smaller additions to utility
Total Utility Curve

TU 35 Total utility(in utils)
30 25
20 15 10 5 0 1 2 3 4 5 Quantity 6 Q
Marginal Utility Curve

MU Marginal utility (in utils) 20 15 10 5 0 -5 1 2 3 4 5 6 Q
Quantity
Consumer Equilibrium
So far, we have assumed that any amount of goods and services are always available for consumption In reality, consumers face constraints (income and prices):
Limited consumers income or budget Goods can be obtained at a price
Some simplifying assumptions

Consumers objective: to maximize his/her utility subject to income constraint 2 goods (X, Y) Prices Px, Py are fixed Consumers income (I) is given
Marginal utility per rupee additional utility derived from spending the next rupee on the good MU per rupee= MU P
Optimizing condition:
MU X MU Y PX PY
If
MU X MU Y PX PY
spend more on good X and less of Y
Marginal Utility and Consumer Choice

Marginal Utility
Marginal utility measures the additional satisfaction obtained from consuming one additional unit of a good.

Marginal Utility
Example
The marginal utility derived from increasing from 0 to 1 units of food might be 9
Increasing from 1 to 2 might be 7 Increasing from 2 to 3 might be 5
Observation: Marginal utility is diminishing

Diminishing Marginal Utility
The principle of diminishing marginal utility states that as more and more of a good is consumed, consuming additional amounts will yield smaller and smaller additions to utility.
Marginal Utility and Consumer Choice Marginal Utility and the Indifference Curve
If consumption moves along an indifference curve, the additional utility derived from an increase in the consumption one good, food (F), must balance the loss of utility from the decrease in the consumption in the other good, clothing (C).
Marginal Utility and Consumer Choice Formally:
0 MUF(F) MUC(C)
Marginal Utility and Consumer Choice Rearranging:
C / F MU F / MU C
C / F MU F / MU C
Because:
C / F MRS of F for C
MRS MUF/MUC
Marginal Utility and Consumer Choice When consumers maximize satisfaction the:
MRS PF/PC
Since the MRS is also equal to the ratio of the marginal utilities of consuming F and C, it follows that:
MUF/MUC PF/PC
Marginal Utility and Consumer Choice Which gives the equation for utility maximization:
MU F / PF MU C / PC
Marginal Utility and Consumer Choice Total utility is maximized when the budget is allocated so that the marginal utility per dollar of expenditure is the same for each good. This is referred to as the equal marginal principle.
Consumer Behavior
There are three steps involved in the study of consumer behavior. 1) We will study consumer preferences.
To describe how and why people prefer one good to another.
Consumer Behavior
There are three steps involved in the study of consumer behavior. 2) Then we will turn to budget constraints.
People have limited incomes.
Consumer Behavior
There are three steps involved in the study of consumer behavior. 3) Finally, we will combine consumer preferences and budget constraints determine consumer choices.
to
What combination of goods will consumers buy to maximize their satisfaction?
Consumer Preferences
Market Baskets
A market basket is a collection of one or more commodities.
One market basket may be preferred over another market basket containing a different combination of goods.
Market Baskets
Three Basic Assumptions 1) Preferences are complete.
2) Preferences are transitive.

3) Consumers always prefer more of any good to less.
Market Basket Units of Food Units of Clothing
A B D E G H
20 10 40 30 10 10
30 50 20 40 20 40
Indifference Curves
Indifference curves represent all combinations of market baskets that provide the same level of satisfaction to a person.
Clothing (units per week) 50 40 B H A E
The consumer prefers A to all combinations in the blue box, while all those in the pink box are preferred to A.
30
20 10 Food (units per week) G D
10
20
30
40
Clothing (units per week) 50 H 40 E A D B
Combination B,A, & D yield the same satisfaction E is preferred to U1 U1 is preferred to H & G
30
20 10
U1
10
20
30
40
Food (units per week)
Indifference Curves
Indifference curves slope downward to the right.
If it sloped upward it would violate the assumption that more of any commodity is preferred to less.
Indifference Curves
Any market basket lying above and to the right of an indifference curve is preferred to any market basket that lies on the indifference curve.
Indifference Maps
An indifference map is a set of indifference curves that describes a persons preferences for all combinations of two commodities.
Each indifference curve in the map shows the market baskets among which the person is indifferent.
Indifference Curves
Finally, indifference curves cannot cross.
This would violate the assumption that more is preferred to less.
Clothing (units per week) Market basket A is preferred to B. Market basket B is preferred to D. B
A U2 U1
U3
Clothing (units per week) U2 U1
Indifference Curves Cannot Cross

The consumer should be indifferent between A, B and D. However, B contains more of both goods than D. B D
Clothing 16 (units per week) 14 12 10 1 -6 B -4 D 6 1 -2 1 -1 1 1 2 3 4 5 Food (units per week) Question: Does this relation hold for giving up food to get clothing? A Observation: The amount of clothing given up for a unit of food decreases from 6 to 1
4
2
Marginal Rate of Substitution
The marginal rate of substitution (MRS) quantifies the amount of one good a consumer will give up to obtain more of another good.
It is measured by the slope of the indifference curve.
Clothing 16 (units per week) 14 12 10 1 -6 B -4 D 6 MRS = 2 1 -2 1 -1 1 1 2 3 4 5 Food (units per week) A MRS = 6
MRS C
4
2
We will now add a fourth assumption regarding consumer preference:

Along an indifference curve there is a diminishing marginal rate of substitution.
Note the MRS for AB was 6, while that for DE was 2.
Question
What are the first three assumptions?
Indifference curves are convex because as more of one good is consumed, a consumer would prefer to give up fewer units of a second good to get additional units of the first one. Consumers prefer a balanced market basket
Perfect Substitutes and Perfect Complements
Two goods are perfect substitutes when the marginal rate of substitution of one good for the other is constant.
Perfect Substitutes and Perfect Complements
Two goods are perfect complements when the indifference curves for the goods are shaped as right angles.
Apple Juice (glasses) 4
Perfect Substitutes
1 Orange Juice (glasses)
Left Shoes
4
Perfect Complements
Right Shoes
BADS
Things for which less is preferred to more
Examples
Air pollution Asbestos
What Do You Think?
How can we account for Bads in the analysis of consumer preferences?
Designing New Automobiles (I)
Automobile executives must regularly decide when to introduce new models and how much money to invest in restyling.
An analysis of consumer preferences would help to determine when and if car companies should change the styling of their cars.
Styling
Consumer Preference A: High MRS
These consumers are willing to give up considerable styling for additional performance
Performance
Styling
Consumer Preference B: Low MRS

These consumers are willing to give up considerable performance for additional styling
Performance
What Do You Think?

How can we determine the consumers preference?
A recent study of automobile demand in the United States shows that over the past two decades most consumers have preferred styling over performance.
Growth of Japanese Imports

1970s and 1980s
15% of domestic cars underwent a style change each year This compares to 23% for imports
Utility
Utility: Numerical score representing the satisfaction that a consumer gets from a given market basket.
Utility
If buying 3 copies of Microeconomics makes you happier than buying one shirt, then we say that the books give you more utility than the shirt.
Utility Functions
Assume: function for food (F) and clothing (C) U(F,C) = F + 2C The utility
Market Baskets: F units C units U(F,C) = F + 2C A 8 3 8 + 2(3) = 14 B 6 4 6 + 2(4) = 14 C 4 4 4 + 2(4) = 12 The consumer is indifferent to A & B The consumer prefers A & B to C
Clothing (units per week) 15
Utility Functions & Indifference Curves Assume: U = FC Market Basket U = FC C 25 = 2.5(10) A 25 = 5(5) B 25 = 10(2.5)
U3 = 100 (Preferred to U2)
B U2 = 50 (Preferred to U1) U1 = 25 Food 15
(units per week)
10
A
5
10
Ordinal Versus Cardinal Utility
Ordinal Utility Function: places market baskets in the order of most preferred to least preferred, but it does not indicate how much one market basket is preferred to another. Cardinal Utility Function: utility function describing the extent to which one market basket is preferred to another.
Ordinal Versus Cardinal Rankings
The actual unit of measurement for utility is not important. Therefore, an ordinal ranking is sufficient to explain how most individual decisions are made.
Budget Constraints
Preferences do not explain all of consumer behavior. Budget constraints also limit an individuals ability to consume in light of the prices they must pay for various goods and services.
Budget Constraints
The Budget Line
The budget line indicates all combinations of two commodities for which total money spent equals total income.
Budget Constraints
The Budget Line
Let F equal the amount of food purchased, and C is the amount of clothing. Price of food = Pf and price of clothing = Pc Then Pf F is the amount of money spent on food, and Pc C is the amount of money spent on clothing.
Budget Constraints
The budget line then can be written:
P FF P C C I
Budget Constraints
Market Basket Food (F) Pf = ($1) Clothing (C) Pc = ($2) Total Spending PfF + PcC = I
40
$80
B
D
20
40
30
20
$80
$80
E
G
60
80
10
0
$80
$80
Budget Constraints
Clothing (units per week) (I/PC) = 40 A B 10 20 20 E 10 G 0 20 40 60 80 = (I/PF)
Pc = $2
Pf = $1
I = $80
Budget Line F + 2C = $80
30
1 Slope C/F - - PF/PC 2

D
Food
(units per week)
Budget Constraints
The Budget Line
As consumption moves along a budget line from the intercept, the consumer spends less on one item and more on the other. The slope of the line measures the relative cost of food and clothing. The slope is the negative of the ratio of the prices of the two goods.
Budget Constraints
The Budget Line
The slope indicates the rate at which the two goods can be substituted without changing the amount of money spent.
Budget Constraints
The Budget Line
The vertical intercept (I/PC), illustrates the maximum amount of C that can be purchased with income I. The horizontal intercept (I/PF), illustrates the maximum amount of F that can be purchased with income I.
Budget Constraints
The Effects of Changes in Income and Prices
Income Changes
An increase in income causes the budget line to shift outward, parallel to the original line (holding prices constant).
Budget Constraints
Income Changes
A decrease in income causes the budget line to shift inward, parallel to the original line (holding prices constant).
Budget Constraints
Clothing (units per week) 80 A increase in income shifts the budget line outward
60
40
A decrease in income shifts the budget line inward

L3 (I = $40) L1 (I = $80) L2 (I = $160)
20
Food
(units per week)
40
80
120
160
Budget Constraints
Price Changes
If the price of one good increases, the budget line shifts inward, pivoting from the other goods intercept.
Budget Constraints
Price Changes
If the price of one good decreases, the budget line shifts outward, pivoting from the other goods intercept.
Budget Constraints
Clothing (units per week) An increase in the price of food to $2.00 changes the slope of the budget line and rotates it inward. A decrease in the price of food to $.50 changes the slope of the budget line and rotates it outward. (PF = 1/2) 120 160
Food
(units per week)
40
L3
(PF = 2) 40
L1
(PF = 1) 80
L2
Budget Constraints
Price Changes
If the two goods increase in price, but the ratio of the two prices is unchanged, the slope will not change.
Budget Constraints
Price Changes
However, the budget line will shift inward to a point parallel to the original budget line.
Budget Constraints
Price Changes
If the two goods decrease in price, but the ratio of the two prices is unchanged, the slope will not change.
Budget Constraints
Price Changes
However, the budget line will shift outward to a point parallel to the original budget line.
Consumer Choice
Consumers choose a combination of goods that will maximize the satisfaction they can achieve, given the limited budget available to them.
Consumer Choice
The maximizing market basket must satisfy two conditions: 1) It must be located on the budget line.
2) Must give the consumer the most preferred combination of goods and services.
Consumer Choice
Recall, the slope of an indifference curve is:
C MRS F
Further, the slope of the budget line is:
PF Slope PC
Consumer Choice
Therefore, it can be said that satisfaction is maximized where:
PF MRS PC
Consumer Choice
It can be said that satisfaction is maximized when marginal rate of substitution (of F and C) is equal to the ratio of the prices (of F and C).
Consumer Choice
Clothing (units per week)
Pc = $2
Pf = $1
I = $80
Point B does not maximize satisfaction because the MRS (-(-10/10) = 1 is greater than the price ratio (1/2).
40 B
30
-10C
Budget Line 20
+10F
U1 40 80
20
Consumer Choice
Pc = $2
Pf = $1
I = $80
40 D 30
Market basket D cannot be attained given the current budget constraint.
20 U3 Budget Line 0 20 40 80
Consumer Choice
Pc = $2
Pf = $1
I = $80
At market basket A the budget line and the indifference curve are tangent and no higher level of satisfaction can be attained.
40
30 A 20
At A: MRS =Pf/Pc = .5 U2 Budget Line
20
40
80
Consumer Choice
Designing New Automobiles (II)
Consider two groups of consumers, each wishing to spend $10,000 on the styling and performance of cars. Each group has different preferences.
Consumer Choice
By finding the point of tangency between a groups indifference curve and the budget constraint auto companies can design a production and marketing plan.

Styling $10,000 These consumers are willing to trade off a considerable amount of styling for some additional performance
$3,000
$7,000
$10,000
Performance

Styling $10,000 $7,000 These consumers are willing to trade off a considerable amount of performance for some additional styling
$3,000
$10,000
Performance
Consumer surplus
And Producer surplus
Definition
Definition In General term: Consumer surplus is willingness to pay less amount paid A/D to Marshall: "excess of the price which a consumer would be willing to pay rather than go without a thing over that which he actually does pay, is the economic measure of this surplus satisfaction it may be called consumer's surplus"
Consumer surplus
What is it? The difference between what you paid, and what you were willing and able to pay. What does it look like? It is the area below the demand curve, and above the equilibrium price.
Consumer surplus
Consumer
surplus Equilibrium Price
Producer Surplus
What is it? The amount a seller is paid, minus the sellers cost. What does it look like? It is the area above the supply curve, and below the equilibrium price.
Producer surplus
Equilibrium Price
Producer surplus
Consumer & producer surplus
Consumer
Producer surplus
The magic of perfectly competitive markets

At equilibrium, both consumer and producer surplus are at their maximum Any interference with the equilibrium price in perfectly competitive markets will reduce total consumer and producer surplus
What effect will rent control have on Consumer and Producer Surplus?
Who are the consumers? Who are the producers?
Price Effect on consumer & producer surplus
Societys
Consumer
loss
Producer surplus
Rent Control
Any interference with the equilibrium price in perfectly competitive markets will reduce total consumer and producer surplus
What effect will a minimum wage have on Consumer and Producer Surplus?
Who are the consumers? Who are the producers?
Price Effect on consumer & producer surplus
Consumer
Societys loss
Minimum wage
surplus
Equilibrium Price
Producer surplus
Measurement of Consumer surplus

Consumer surplus- buyers willingness to pay minus the actual price paid
CS = Marginal Benefit Price Paid (measures how much a consumer values a good/service Called the marginal benefit )(MB)
TYPES OF Consumer Surplus

Individual consumer surplus is the net gain to an individual buyer from the purchase of a good. It is equal to the difference between the buyers willingness to pay and the price paid.
Total consumer surplus is the sum of the individual consumer surpluses of all the buyers of a good.
The term consumer surplus is often used to refer to both individual and to total consumer surplus.
Conclusion
The consumer surplus will increase when the price decreases. The consumer surplus will decrease when the price increases.

By: Deepali Mandalia

Загружено:

Сведения о документе

Исходное описание:

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

By: Deepali Mandalia

Загружено:

Авторское право:

Доступные форматы

Module II

By: Deepali Mandalia

Theory of Consumer Behavior

Total utility and marginal utility

Total utility and marginal utility

Total Utility Curve

Marginal Utility Curve

Some simplifying assumptions

spend more on good X and less of Y

Marginal Utility and Consumer Choice

Marginal Utility and Consumer Choice

Observation: Marginal utility is diminishing

Marginal Utility and Consumer Choice

Marginal Utility and Consumer Choice Formally:

Marginal Utility and Consumer Choice Rearranging:

Marginal Utility and Consumer Choice

What combination of goods will consumers buy to maximize their satisfaction?

A market basket is a collection of one or more commodities.

Three Basic Assumptions 1) Preferences are complete.

2) Preferences are transitive.

Food (units per week)

Indifference curves slope downward to the right.

Finally, indifference curves cannot cross.

This would violate the assumption that more is preferred to less.

Food (units per week)

Indifference Curves Cannot Cross

Food (units per week)

It is measured by the slope of the indifference curve.

We will now add a fourth assumption regarding consumer preference:

Perfect Substitutes and Perfect Complements

Perfect Substitutes and Perfect Complements

1 Orange Juice (glasses)

Consumer Preference A: High MRS

Consumer Preference B: Low MRS

What Do You Think?

Growth of Japanese Imports

Budget Line F + 2C = $80

1 Slope C/F - - PF/PC 2

A decrease in income shifts the budget line inward

Food (units per week)

Market basket D cannot be attained given the current budget constraint.

Food (units per week)

At A: MRS =Pf/Pc = .5 U2 Budget Line

Food (units per week)

Designing New Automobiles (II)

Designing New Automobiles (II)

Consumer & producer surplus

The magic of perfectly competitive markets

Price Effect on consumer & producer surplus

Price Effect on consumer & producer surplus

Measurement of Consumer surplus

TYPES OF Consumer Surplus

Вам также может понравиться