week 1 ch3 consumer behavior

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Copyright © 2013 Pearson Education, Inc. • Microeconomics • Pindyck!u"in#e$d, %e. 3 of 40

C H A P T E R 3Consumer &eha'ior CHAPTER OTLINE

Week 13.1 Consumer Pre#erences

3.2 &udget Constraints

3.3 Consumer Choice

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•Consumer Behavior

Theory of co!"#er $eh%&'or ( (escription o# ho) consumers

a$$ocate *$imited+ incomes among di##erent goods and ser'ices tomaimi-e their )e$$"eing.

Consumer "eha'ior is "est understood in 3 distinct steps/

1) Co!"#er Preferece!

2) *"+,e- Co!-r%'-!

3) Co!"#er Cho'ce!

WHAT .O CON/ER/ .O

!ecent mode$s o# consumer "eha'ior incorporate more rea$istic assumptions a"out rationa$ity and decision making.

"asic )orkhorse o# economics, our mode$ makes simplifying assumptions to ep$ain much o# )hat )e actua$$y o"ser'e regarding consumer choice and thecharacteristics o# consumer demand.



• Consumer Preferences3)1

• Market Baskets

● #%rke- $%!ke- *or $"+e+ ist )ith speci#ic 4uantities o# one or more

goods.

TA*LE 3)1 ALTERNATIE ARET *A/ET/

A 20 30B 10 50

D 60 20

E 30 60

G 10 20

H 10 60

ARET *A/ET NIT/ O OO. NIT/ O CLOTHIN

7o ep$ain the theory o# consumer "eha'ior, )e )i$$ ask )hether consumers prefer one market "asket to another.



• Some Basic Assumptions about Preferences

1) Co#e-e(e!! Pre#erences are assumed to "e complete.Consumers can compare and rank a$$ possi"$e "askets. 7hus,

#or any t)o market "askets A and B, a consumer )i$$ pre#er Ato B, )i$$ pre#er B to A, or )i$$ "e indi##erent "et)een the t)o.&y indifferent )e mean that a person )i$$ "e e4ua$$y satis#ied)ith either "asket.

• Ignore costs a consumer might pre#er steak to ham"urger$"- "uy ham"urger "ecause it is cheaper.

2) Tr%!'-'&'-y Pre#erences are transitive i# a consumerpre#ers "asket A to "asket B and "asket B to "asket C , thenthe consumer a$so pre#ers A to C . 7ransiti'ity is norma$$yregarded as necessary #or consumer consistency.

3) ore '! $e--er -h% e!! 8oods are assumed to "edesira"$e9i.e., to "e good . Conse4uent$y, consumers always

prefer more of any good to less. In addition, consumers arene'er satis#ied or satiated: more is always better, even if just

a little better .



.E/CRI*IN IN.II.AL

PREERENCE/

&ecause more o# each

good is pre#erred to $ess,)e can compare market"askets in the shadedareas.

&asket A is c$ear$ypre#erred to "asket G,)hi$e E is c$ear$ypre#erred to A.

;o)e'er, A cannot "ecompared )ith B, D, or H )ithout additiona$in#ormation. IRE 3)1

• Indifference Curvesrepresenting a$$ com"inations o# market "askets thatpro'ide a consumer )ith the same $e'e$ o#satis#action.



7he indi##erence cur'eU 1 that passes through

market "asket A sho)sa$$ "askets that gi'e theconsumer the same$e'e$ o# satis#action asdoes market "asket A:

these inc$ude "askets B and D.

AN IN.IERENCE CREIRE 3)2

<ur consumer pre#ers"asket E , )hich $iesa"o'e U 1, to A, "ut

pre#ers A to H or G,)hich $ie "e$o) U 1.



n indi##erence map isa set o# indi##erencecur'es that descri"esa person=spre#erences.

AN IN.IERENCE AP

IRE 3)3

• Indifference Maps 8raph containing a set o# indi##erence cur'es sho)ing themarket "askets among )hich a consumer is indi##erent.

ny market "asket onindi##erence cur'e U 3,

such as "asket A, ispre#erred to any

"asket on cur'e U 2 *e.g., "asket B+, )hichin turn is pre#erred toany "asket on U 1,

such as D.



I# indi##erence cur'es U 1

and U 2 intersect, one o#

the assumptions o#consumer theory is'io$ated.

IN.IERENCE CRE/

CANNOT INTER/ECT

IRE 3)4

ccording to this diagram, the

consumer shou$d "eindi##erent among market"askets A, B, and D. >et B shou$d "e pre#erred to D "ecause B has more o# "othgoods.



7he magnitude o# the

s$ope o# an indi##erencecur'e measures theconsumer?s margina$rate o# su"stitution*M!@+ "et)een t)ogoods.

THE ARINAL RATE

O /*/TITTIONIRE 3)5

•The Shape of Indifference Curves

In this #igure, the M!@"et)een c$othing *C + and#ood * + #a$$s #rom A*"et)een A and B+ to 6

*"et)een B and D+ to 2*"et)een D and E + to 1*"et)een E and G+.

MRSof F forC =themaximum

amount ofC that

a person iswilling to give upto obtain oneadditional unit of

F.



•The Marginal Rate of Substitution,MRS

(: Maimum amount o# a good that a consumer is )i$$ing to

gi'e up in order to o"tain one additiona$ unit o# another good.

CONE;IT< ( the M!@ #a$$s as )e mo'e do)n theindi##erence cur'e. 7he dec$ine in the M!@ re#$ects our #ourth

assumption regarding consumer pre#erences/ a +'#''!h',

#%r,'% r%-e of !"$!-'-"-'o. Bhen the M!@

diminishes a$ong an indi##erence cur'e, the cur'e is con'e.

Perectus uesan Perect



Perectus ues an PerectComplements

= Perfec- !"$!-'-"-e! 7)o goods #or )hich the M!@ o# one #or the

other is a constant.



= Perfec- co#e#e-! ( 7)o goods #or )hich the M!@ is -eroor in#inite: the indi##erence cur'es are shaped as right ang$es.

=

*%+ 8ood #or )hich$ess is pre#erred ratherthan more.



In *a+, &o" 'ie)s orange uice andapp$e uice as per#ect su"stitutes/;e is a$)ays indi##erent "et)een ag$ass o# one and a g$ass o# theother.

PERECT /*/TITTE/ AN. PERECT COPLEENT/

IRE 3)6

In *b+, Dane 'ie)s $e#t shoes and rightshoes as per#ect comp$ements/ nadditiona$ $e#t shoe gi'es her no etrasatis#action un$ess she a$so o"tains thematching right shoe.



uti$ity #unction can "erepresented "y a set o#indi##erence cur'es,

each )ith a numerica$indicator.

7his #igure sho)s threeindi##erence cur'es*)ith uti$ity $e'e$s o# 25,50, and 100,respecti'e$y+associated )ith theuti$ity #unction.

• UTILITY AND UTILITY FUNCTIONS

-''-y ( umerica$ scorerepresenting the satis#action that a

consumer gets #rom a gi'en market"asket.

-''-y f"c-'o

Formu$a that assigns a$e'e$ o# uti$ity to

indi'idua$market "askets.

TILIT< NCTION/ AN.

IN.IERENCE CRE/IRE 3)8

u

(F

,C

) =FC



crosscountrycomparison sho)s thatindi'idua$s $i'ing incountries )ith higher8(P per capita are on

a'erage happier thanthose $i'ing in countries)ith $o)er percapita8(P.

• ORDINAL VERSUS CARDINAL UTILITY

= Or+'% "-''-y f"c-'o ( Gti$ity #unction that generates aranking o#

market "askets in order o# most to $east pre#erred.= C%r+'% "-''-y f"c-'o ( Gti$ity #unction descri"ing "y ho)much one market "asket is pre#erred to another.

INCOE AN. HAPPINE//IRE 3)9

EHMPE 3.2 CAN ONE< *< HAPPINE//



Market "askets associated )ith the "udget $ine 2C J K%0

• The Budget Line

*"+,e- co!-r%'-! Constraints that consumers #ace as a resu$t

o# $imited incomes.

$$ com"inations o# goods #or )hich the tota$ amount o#money spent is e4ua$ to income.

• Budget Constraints3)2

TA*LE 3)2 ARET *A/ET/ AN. THE *.ET LINE

ARET *A/ET OO. >F ? CLOTHIN >C ? TOTAL /PEN.IN

A 0 60 K%0

B 20 30 K%0

D 60 20 K%0

E A0 10 K%0

G %0 0 K%0

(3.1) I C P F P C F

=+



ine AG *)hich passes throughpoints B, D, and E + sho)s the"udget associated )ith anincome o# K%0, a price o# #ood

o# ! J K1 per unit, and a

price o# c$othing o# ! C J K2per unit.

7he s$ope o# the "udget $ine*measured "et)een points

B and D+ isL*! ! C + J L1020 J

L12.

A *.ET LINE

IRE 3)10

(3.2)

F P P P I C C F C

)/()/( −=



change in income *)ithprices unchanged+ causesthe "udget $ine to shi#t para$$e$to the origina$ $ine *"1+.

Bhen the income o# K%0 *on

"1+ is increased to K1A0, the

"udget $ine shi#ts out)ard to"2.

I# the income #a$$s to K60, the$ine shi#ts in)ard to "3.

• The Effects of Changes in Income and Prices

EECT/ O A CHANE IN

INCOE ON THE *.ET

LINE

IRE 3)11




change in the price o# onegood *)ith incomeunchanged+ causes the

"udget $ine to rotate a"outone intercept.

Bhen the price o# #ood #a$$s#rom K1.00 to K0.50, the"udget $ine rotates out)ard

#rom "1 to "2.

EECT/ O A CHANE IN

PRICE ON THE *.ET

LINE

IRE 3)12

PRICE CHANE/

;o)e'er, )hen the price increases #rom K1.00 to K2.00,the $ine rotates in)ard #rom 1 to "3.




7he maimi-ing market "asket must satis#y t)o conditions/

• Consumer Choice3)3

1. #t must be located on t$e budget line.

2. #t must give t$e consumer t$e most preferred

combination of goods and services.




consumer maimi-essatis#action "y choosingmarket "asket A. t this

point, the "udget $ine andindi##erence cur'e U 2 are

tangent.

%o $ig$er level of

satisfaction *e.g., market

"asket D+ can "e attained. t A, the point o#maimi-ation, -he MRS

between the two goods

equals the price ratio. tB, ho)e'er, "ecause the

R/ @ *L1010+ J 1N isgreater than the price ratio( *12+, satis#action is notmaimi-ed.

A;IIIN CON/ER

/ATI/ACTIONIRE 3)13




%r,'% $eef'- ( &ene#it #rom the consumption o# one additiona$unit o# a good.

%r,'% co!- ( Cost o# one additiona$ unit o# a good.

@o, )e can then say that satis#action is maimi-ed )hen the%r,'% *eef'- e4ua$ to the %r,'% Co!-)

7hemargina$ "ene#it

is measured "y the M!@.

@atis#action is maimi-ed *gi'en the "udget constraint+ at the point )here

MRS = P F / P C (3.3)



@ituation in )hich the M!@ #or one good in a chosen market"asket is not e4ua$ to the s$ope o# the "udget $ine.

IRE 3)15

Corer /o"-'o!

Bhen a corner so$ution arises,the consumer maimi-es

satis#action "y consuming on$yoe o# the t)o goods.

8i'en "udget $ine AB, thehighest $e'e$ o# satis#actionis achie'ed at B onindi##erence cur'e U 1, )here

the M!@ *o# ice cream #or

#ro-en yogurt+ is greaterthan the ratio o# the price o#ice cream to the price o##ro-en yogurt.

week 1 ch3 consumer behavior

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