chapter 3 consumer behavior

Chapter Consumer Behavior Topics to be Discussed  Consumer Preferences  Budget Constraints  Consumer Choice  Revealed Preferences  Marginal Utility and Consumer Choice  Cost-of-Living Index Chapter 3: Consumer Behavior Slide 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. Chapter 3: Consumer Behavior Slide 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. Chapter 3: Consumer Behavior Slide Consumer Behavior  There are three steps involved in the study of consumer behavior. 3) Finally, we will combine consumer preferences and budget constraints to determine consumer choices.  What combination of goods will consumers buy to maximize their satisfaction? Chapter 3: Consumer Behavior Slide Consumer Preferences Market Market Baskets Baskets  A market basket is a collection of one or more commodities.  One market basket may be preferred to another market basket containing a different combination of goods. Chapter 3: Consumer Behavior Slide Consumer Preferences Market Market Baskets Baskets  Three Basic Assumptions 1) Preferences are complete. 2) Preferences are transitive. 3) Consumers always prefer more of any good to less. Chapter 3: Consumer Behavior Slide Consumer Preferences Market Basket Units of Food Clothing Units of A 20 30 B 10 50 D 40 20 E 30 40 G 10 20 H 10 40 Chapter 3: Consumer Behavior Slide Consumer Preferences Indifference Indifference Curves Curves  Indifference curves represent all combinations of market baskets that provide the same level of satisfaction to a person. Chapter 3: Consumer Behavior Slide Consumer Preferences Clothing (units per week) 50 B 40 H The consumer prefers A to all combinations in the blue box, while all those in the pink box are preferred to A. E A 30 D G 20 10 10 20 Chapter 3: Consumer Behavior 30 40 Food (units per week) Slide Marginal Utility and Consumer Choice Marginal Marginal Utility Utility  Marginal utility measures the additional satisfaction obtained from consuming one additional unit of a good. Chapter 3: Consumer Behavior Slide Marginal Utility and Consumer Choice Marginal Marginal Utility Utility  Example  The marginal utility derived from increasing from to units of food might be   Increasing from to might be  Increasing from to might be Observation: Marginal utility is diminishing Chapter 3: Consumer Behavior Slide Marginal Utility and Consumer Choice Diminishing Diminishing Marginal Marginal Utility 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. Chapter 3: Consumer Behavior Slide 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 of one good, food (F), must balance the loss of utility from the decrease in the consumption in the other good, clothing (C). Chapter 3: Consumer Behavior Slide Marginal Utility and Consumer Choice  Formally: = MUF(∆F) + MUC(∆C) Chapter 3: Consumer Behavior Slide Marginal Utility and Consumer Choice  Rearranging: − ( ∆C / ∆F ) = MU F / MU C Chapter 3: Consumer Behavior Slide Marginal Utility and Consumer Choice − ( ∆C / ∆F ) = MU F / MU C  Because: − ( ∆C / ∆F ) = MRS of F for C MRS = MUF/MUC Chapter 3: Consumer Behavior Slide 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 Chapter 3: Consumer Behavior Slide Marginal Utility and Consumer Choice  Which gives the equation for utility maximization: MU F / PF = MU C / PC Chapter 3: Consumer Behavior Slide 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. Chapter 3: Consumer Behavior Slide Cost-of-Living Index  The CPI is calculated each year as the ratio of the cost of a typical bundle of consumer goods and services today in comparison to the cost during a base period. Chapter 3: Consumer Behavior Slide Summary  People behave rationally in an attempt to maximize satisfaction from a particular combination of goods and services.  Consumer choice has two related parts: the consumer’s preferences and the budget line. Chapter 3: Consumer Behavior Slide Summary  Consumers make choices by comparing market baskets or bundles of commodities.  Indifference curves are downward sloping and cannot intersect one another.  Consumer preferences can be completely described by an indifference map. Chapter 3: Consumer Behavior Slide Summary  The marginal rate of substitution of F for C is the maximum amount of C that a person is willing to give up to obtain one additional unit of F.  Budget lines represent all combinations of goods for which consumers expend all their income. Chapter 3: Consumer Behavior Slide Summary  Consumers maximize satisfaction subject to budget constraints.  The theory of revealed preference shows how the choices that individuals make when prices and income vary can be used to determine their preferences. Chapter 3: Consumer Behavior Slide End of Chapter [...]... the goods are shaped as right angles Chapter 3: Consumer Behavior Slide Consumer Preferences Apple Juice (glasses) 4 Perfect Perfect Substitutes Substitutes 3 2 1 0 1 2 Chapter 3: Consumer Behavior 3 4 Orange Juice (glasses) Slide Consumer Preferences Left Shoes 4 Perfect Perfect Complements Complements 3 2 1 0 1 2 Chapter 3: Consumer Behavior 3 4 Right Shoes Slide Consumer Preferences  Utility  Utility:... indifferent Chapter 3: Consumer Behavior Slide Consumer Preferences  Indifference Curves  Finally,  indifference curves cannot cross This would violate the assumption that more is preferred to less Chapter 3: Consumer Behavior Slide Consumer Preferences Clothing (units per week) Market basket A is preferred to B Market basket B is preferred to D D B A U3 U2 U1 Food (units per week) Chapter 3: Consumer Behavior. .. good a consumer will give up to obtain an additional unit of another good, given the same level of satisfaction  It is measured by the slope of the indifference curve Chapter 3: Consumer Behavior Slide Consumer Preferences A Clothing 16 (units per week) 14 12 MRS = − ∆C MRS = 6 -6 10 B 1 8 ∆F -4 D 6 MRS = 2 1 -2 4 E G 1 -1 1 2 1 2 3 4 Chapter 3: Consumer Behavior 5 Food (units per week) Slide Consumer. .. satisfaction that a consumer gets from a given market basket Chapter 3: Consumer Behavior Slide Consumer Preferences  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 function: formula that assigns a level of utility to individual market baskets Chapter 3: Consumer Behavior Slide Consumer Preferences... units of the first one  Consumers prefer a balanced market basket Chapter 3: Consumer Behavior Slide Consumer Preferences Marginal Rate of Substitution Marginal Rate of Substitution  Perfect Substitutes and Perfect Complements  Two goods are perfect substitutes when the marginal rate of substitution of one good for the other is constant Chapter 3: Consumer Behavior Slide Consumer Preferences Marginal... would violate the assumption that more of any commodity is preferred to less Chapter 3: Consumer Behavior Slide Consumer Preferences  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 Chapter 3: Consumer Behavior Slide Consumer Preferences Indifference Maps Indifference Maps  An indifference... = 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 Chapter 3: Consumer Behavior Slide Consumer Preferences Utility Functions & Indifference Curves Utility Functions & Indifference Curves Clothing (units per week) Assume: U = FC Market Basket U = FC C 25 = 2.5(10) A 25 = 5(5) B 25 = 10(2.5) 15 C 10 U3 = 100 (Preferred... describing the extent to which one market basket is preferred to another Chapter 3: Consumer Behavior Slide Budget Constraints  Preferences do not explain all of consumer behavior  Budget constraints also limit an individual’s ability to consume in light of the prices they must pay for various goods and services Chapter 3: Consumer Behavior Slide Budget Constraints  The Budget Line  The budget line... PFF + PCC = I Chapter 3: Consumer Behavior Slide Budget Constraints Market Basket Spending =I A Food (F) Pf = ($1) 0 Clothing (C) Pc = ($2) Total PfF + PcC 40 $80 B 20 30 $80 D 40 20 $80 E 60 10 $80 G 80 0 $80 Chapter 3: Consumer Behavior Slide Budget Constraints Clothing (units per week) (I/PC) = 40 Pc = $2 Pf = $1 I = $80 Budget Line F + 2C = $80 A 1 Slope = ∆C/∆F = - = - PF/PC 2 B 30 10 20 D 20... which total money spent equals total income Chapter 3: Consumer Behavior Slide 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 Chapter 3: Consumer Behavior Slide Budget Constraints  The budget . Baskets Chapter 3: Consumer Behavior Slide 8 Consumer Preferences 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 Chapter 3: Consumer Behavior Slide 9 Consumer. Utility and Consumer Choice  Cost-of-Living Index Chapter 3: Consumer Behavior Slide 3 Consumer Behavior  There are three steps involved in the study of consumer behavior. 1) We will study consumer. have limited incomes. Chapter 3: Consumer Behavior Slide 5 Consumer Behavior  There are three steps involved in the study of consumer behavior. 3) Finally, we will combine consumer preferences