bus ecn-consumer bhv 06.ppt

8/14/2019 bus ecn-consumer bhv 06.ppt

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Fernando & Yvonn Quijano

Prepared by:

ConsumerBehavior

3

C H A

P T E R

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Microeconomics Pindyck/Rubinfeld, 7e.


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2 of 37Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Microeconomics Pindyck/Rubinfeld, 7e.

CHAPTER 3 OUTLINE

3.1 Consumer Preferences

3.2 Budget Constraints

3.3 Consumer Choice

3.4 Revealed Preference

3.5 Marginal Utility and Consumer Choice

3.6 Cost-of-Living Indexes


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Consumer Behavior

theory of consumer behavior Description of howconsumers allocate incomes among different goods andservices to maximize their well-being.

Consumer behavior is best understood in three distinct steps:1. Consumer preferences

2. Budget constraints

3. Consumer choices


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CONSUMER PREFERENCES3.1Market Baskets

market basket (or bundle ) List with specific quantitiesof one or more goods.

TABLE 3.1 Alternative Market Baskets

A 20 30

B 10 50

D 40 20

E 30 40

G 10 20

H 10 40

Market Basket Units of Food Units of Clothing

To explain the theory of consumer behavior, we will askwhether consumers prefer one market basket to another.


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CONSUMER PREFERENCES3.1Some Basic Assumptions about Preferences

1. Completeness: Preferences are assumed to be complete . Inother words, consumers can compare and rank all possiblebaskets. Thus, for any two market baskets A and B, a consumerwill prefer A to B, will prefer B to A , or will be indifferent between

the two. By indifferent we mean that a person will be equallysatisfied with either basket.

Note that these preferences ignore costs. A consumer mightprefer steak to hamburger but buy hamburger because it ischeaper.


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Utility from Consuming Two Goods

Assume that person receives utility from consumption oftwo goods X and Y, which we show in functionalnotation by

Other factors that may affect utility are assumed to be heldconstant.

gs).other thin;,( Y X U Utility


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MARGINAL UTILITY AND CONSUMER CHOICE3.5 marginal utility (MU) Additional satisfaction obtained

from consuming one additional unit of a good. diminishing marginal utility Principle that as more of a good is

consumed, the consumption of additional amounts will yieldsmaller additions to utility.

( / ) MU MU ( )C F C F C

0 MU ( ) MU ( ) F C F C

MRS MU /MU (3.5) F C MRS / (3.6) P P F C

MU /MU / P P F F C C MU / MU / (3.7) P P F F C C

equal marginal principle Principle that utility is maximizedwhen the consumer has equalized the marginal utility per dollar ofexpenditure across all goods.


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10 of 37Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Microeconomics Pindyck/Rubinfeld, 7e.Chapter 3: Consumer Behavior Slide 10

Marginal utility = the additional satisfaction obtainedfrom consuming one additional unit of a good.

ExampleThe marginal u t i l i ty derived f rom increas ing f rom

0 to 1 uni t s o f food m ight be 9

Increas ing f rom 1 to 2 migh t be 7

Increas ing f rom 2 to 3 migh t be 5

Observation: Marginal utility is diminishing : as more andmore of a good is consumed, consuming additionalamounts will yield smaller and smaller additions toutility.

Marginal Utility and Consumer Choice

arginal Utility


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Rice (plates)per week, y

6 A

B

C

D

U1

4

3

2

Soft drinksper week, x

2 3 4 5 6 0

Indifference Curve


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riceper week, y

6 A

B

C

E

D

U1

4

3

2

Soft drinksper week,x

2 3 4 5 6 0

Indifference Curve


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Points Above Indifference CurvePoints such as E are above (to northeast) of U 1.

Since E has m ore of both goo ds th an point C, E is preferred toC (mo re is bet ter).

E is preferred to any p oint on U 1 .

Points abov e indifference curv e preferred to po ints on curv e.


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The indifference curve U 1 thatpasses through market basket

A shows all baskets that givethe consumer the same level ofsatisfaction as does marketbasket A; these includebaskets B and D.

An Indifference Curve

CONSUMER PREFERENCES3.1

Figure 3.2

Indifference curves

indifference curve Curve representing all combinations of marketbaskets that provide a consumer with the same level of satisfaction.

Our consumer prefers basketE , which lies above U 1, to A ,but prefers A to H or G , whichlie below U 1.


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An indifference map is a set ofindifference curves thatdescribes a person'spreferences.

An Indifference Map


Figure 3.3

Indifference Maps

indifference map Graph containing a set of indifference curvesshowing the market baskets among which a consumer is indifferent.

Any market basket onindifference curve U 3, such asbasket A , is preferred to anybasket on curve U 2 (e.g.,

basket B), which in turn ispreferred to any basket on U 1,such as D.


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Indifference Curves:Marginal Rate of Substitution

Marginal Rate of Substitution (MRS): Rate at whichindividual will reduce consumption of one good to get onemore unit of other good.

Measured as negat ive of indifferenc e curve s lo pe

MRS be tween po in t s A and B o n U 1 (approximately)-2.


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Diminishing Marginal Rate of Substitution

Refer to the above diagram, the ,consumer will only give upone rice to gain one more unit of soft drink betweenpoints B and C.

Between points C and D, consumer will give up only riceto gain one more soft drink.


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Diminishing Marginal Rate of Substitution

MRS diminishes along indifference curve moving from leftto right.

Reflects idea that consumers prefer balanced

consumptionPoint G reflects bundle that is between points A and D. Since i t i s above U 1 ,poin t G preferable to any bun dle on

indifference curv e.


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riceper week

6 A

B

C

G

D U1

4

3

2

Soft drinksper week 2 3 4 6 0

Consumer Prefers Balanced Consumption


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The magnitude of the slope of an

indifference curve measures theconsumers marginal rate ofsubstitution (MRS) between two goods.

The Marginal Rate of Substitution


Figure 3.5

The Marginal Rate of Substitution

In this figure, the MRS between clothing(C ) and food ( F ) falls from 6 (between A and B) to 4 (between B and D) to 2(between D and E ) to 1 (between E and

G).Convexity The decline in the MRSreflects a diminishing marginal rate ofsubstitution . When the MRSdiminishes along an indifference curve,the curve is convex.

marginal rate of substitution Maximum amount of a good that aconsumer is willing to give up in order to obtain one additional unit ofanother good.


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A utility function can berepresented by a set ofindifference curves, eachwith a numericalindicator.

This figure shows threeindifference curves (withutility levels of 25, 50,and 100, respectively)associated with the utilityfunction:

Utility and Utility Functions utility Numerical score representing the satisfaction that a

consumer gets from a given market basket.

utility function Formula that assigns a level of utility to individualmarket baskets.

Utility Functions and Indifference Curves

Figure 3.8

u (F ,C ) = FC


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A cross-countrycomparison shows thatindividuals living incountries with higherGDP per capita are onaverage happier thanthose living in countrieswith lower per-capitaGDP.

Ordinal versus Cardinal Utility ordinal utility function Utility function that generates a ranking

of market baskets in order of most to least preferred.

cardinal utility function Utility function describing by how muchone market basket is preferred to another.

Income and Happiness

Figure 3.9


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A utility function can berepresented by a set ofindifference curves, eachwith a numericalindicator.

This figure shows threeindifference curves (withutility levels of 25, 50,and 100, respectively)associated with the utilityfunction:

Utility Functions and Indifference Curves

u (F ,C ) = FC


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BUDGET CONSTRAINTS3.2

A budget line describes thecombinations of goods that can bepurchased given the consumersincome and the prices of the goods.

Line AG (which passes throughpoints B, D, and E ) shows thebudget associated with an incomeof $80, a price of food of P F = $1 perunit, and a price of clothing of P C =$2 per unit.

The slope of the budget line

(measured between points B and D)is P F /P C = 10/20 = 1/2.

The Budget Line

A Budget LineFigure 3.10


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Budget Constraint Algebra

Real income, if all income spent on Y, I/P Y will bepurchased, and if all income is spent on X, I/P X will bepurchased.

The slope of budget line (-P X/P Y) represents opportunitycost of X in terms of foregone Y.


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Income changes A change inincome (with prices unchanged)causes the budget line to shiftparallel to the original line ( L1).When the income of $80 (on L1) isincreased to $160, the budget lineshifts outward to L2.

If the income falls to $40, the lineshifts inward to L3.

The Effects of Changes in Income and Prices

Effects of a Change in Income on theBudget Line

Figure 3.11


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Price changes A change in theprice of one good (with incomeunchanged) causes the budget lineto rotate about one intercept.When the price of food falls from$1.00 to $0.50, the budget linerotates outward from L1 to L2.

However, when the price increasesfrom $1.00 to $2.00, the line rotatesinward from L1 to L

3.

The Effects of Changes in Income and Prices

Effects of a Change in Price on theBudget Line

Figure 3.12


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Hamburgersper week

Y*

B

A

C

D Income

U2

Soft drinksper week 0

X*

FIGURE 2-7: Graphic Demonstration of Utility Maximization

U3

U1


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Utility Maximization

At point C, all income is spent. At point C, indifference curve U 2 lies tangent to budget line,

so

or curveceindifferenof Slopeconstraint budgetof Slope

. MRS P P

Y

X


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CONSUMER CHOICE3.3

A consumer maximizes satisfactionby choosing market basket A . Atthis point, the budget line andindifference curve U 2 are tangent.

No higher level of satisfaction (e.g.,market basket D) can be attained.

At A , the point of maximization, the

MRS between the two goods equalsthe price ratio. At B, however,because the MRS [ (10/10) = 1] isgreater than the price ratio (1/2),satisfaction is not maximized.

Maximizing Consumer Satisfaction

Figure 3.13

The maximizing market basket must satisfy two conditions:1. It must be located on the budget line.2. It must give the consumer the most preferred combination of

goods and services.


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CONSUMER CHOICE3.3

marginal benefit Benefit from the consumption of oneadditional unit of a good.

marginal cost Cost of one additional unit of a good.

Using these definitions, we can then say that satisfaction ismaximized when the marginal benefit the benefit associatedwith the consumption of one additional unit of food is equal tothe marginal cost the cost of the additional unit of food. Themarginal benefit is measured by the MRS.

Satisfaction is maximized (given the budget constraint) at thepoint where MRS = P F /P C .


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MARGINAL UTILITY AND CONSUMER CHOICE3.5 marginal utility (MU) Additional satisfaction obtained

from consuming one additional unit of a good. diminishing marginal utility Principle that as more of a good isconsumed, the consumption of additional amounts will yieldsmaller additions to utility.

( / ) MU MU ( )C F C F C

0 MU ( ) MU ( ) F C F C

MRS MU /MU (3.5) F C MRS / (3.6) P P F C MU /MU / P P

F F C C MU / MU / (3.7) P P F F C C

equal marginal principle Principle that utility is maximizedwhen the consumer has equalized the marginal utility per dollar ofexpenditure across all goods.


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Consumer Choice of Automobile Attributes

CONSUMER CHOICE3.3

The consumers in (a) are willing to trade off a considerable amount of interior spacefor some additional acceleration. Given a budget constraint, they will choose a carthat emphasizes acceleration. The opposite is true for consumers in (b).

Figure 3.14


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CONSUMER CHOICE3.3

When a corner solution arises,the consumer maximizessatisfaction by consuming onlyone of the two goods.

Given budget line AB , the highestlevel of satisfaction is achieved atB on indifference curve U 1, where

the MRS (of ice cream for frozenyogurt) is greater than the ratio ofthe price of ice cream to the priceof frozen yogurt.

Corner Solutions

A Corner Solution

Figure 3.15

corner solution Situation in which the marginal rate ofsubstitution for one good in a chosen market basket isnot equal to the slope of the budget line.


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A College Trust Fund

CONSUMER CHOICE3.3

When given a collegetrust fund that must bespent on education, thestudent moves from A toB, a corner solution.If, however, the trust fundcould be spent on otherconsumption as well aseducation, the studentwould be better off at C .

Figure 3.16


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Marginal Utility and Happiness

MARGINAL UTILITY AND CONSUMER CHOICE3.5

A comparison of mean levels of satisfaction with life across income classes in theUnited States shows that happiness increases with income, but at a diminishing rate.

Figure 3.20


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Inefficiency of Gasoline Rationing


When a good is rationed, lessis available than consumerswould like to buy. Consumersmay be worse off. Withoutgasoline rationing, up to 20,000gallons of gasoline areavailable for consumption (atpoint B).The consumer chooses point C on indifference curve U 2,consuming 5000 gallons ofgasoline.However, with a limit of 2000gallons of gasoline underrationing (at point E ), theconsumer moves to D on thelower indifference curve U 1.

Figure 3.21


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Comparing Gasoline Rationing to theFree Market


If the price of gasoline in a competitivemarket is $2.00 per gallon and themaximum consumption of gasoline is10,000 gallons per year, the woman isbetter off under rationing (which holdsthe price at $1.00 per gallon), sinceshe chooses the market basket atpoint F , which lies below indifferencecurve U 1 (the level of utility achievedunder rationing).

However, she would prefer a freemarket if the competitive price were$1.50 per gallon, since she wouldselect market basket G , which liesabove indifference curve U 1.

Figure 3.22

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