The theories of consumer behavior (KINH tế VI mô SLIDE)

4 The Theories of Consumer Behavior MICROECONOMICS Overview Theories of consumer behavior Explanation of how consumers allocate income to purchase different goods and services (market basket)  Utility Theory  Theory of Consumer Choice Three steps: Consumer Preference Budget Constraint Given preferences and limited incomes, what amount and type of goods will be purchased? Utility Theory  Utility is the satisfaction or pleasure that a consumer gets from consuming a given bundle of goods or service (market basket) E.g.Utility for coffee Number of cups Utility Marginal utility 0 6 10 13 15 16 Utility    a numerical indicator of a person’s satisfaction If one item is preferred to some alternative, the utility from the item is greater than the alternative Actual unit of measurement for utility is not important (ordinal, not cardinal, ranking is sufficient)  Consumers try to obtain the largest possible total satisfaction (utility) from the market basket that they buy with their incomes Utility Function  Formula that assigns level of utility to individual market baskets Baskets of X and Y U = f (X; Y) E.g.: Baskets (X-Coffee; Y-Sweets) U = X.Y or U = X1/2.Y1/2   Consumer’s purpose: maximizing total utility  Umax Marginal Utility (MU)  MU measures additional satisfaction obtained from consuming additional unit of goods or service   How much happier is individual from consuming one more unit of coffee The change in total utility due to a one-unit change in the quantity of a good or service ∆U MU = ∆Q Marginal utility -MU Number of cups Utility MU 0 6 10 13 15 16 Observation: Marginal Utility is diminishing as consumption increase Marginal utility   Principle of Diminishing marginal utility: As more good is consumed, additional utility consumer gains will be smaller and smaller Note: total utility will continue to increase since consumer makes choices that make them happier Application    ⇒ Diminishing marginal utility and demand curve To a consumer, the larger marginal utility, the higher willingness to pay The smaller MU, the lower willingness to pay The diminishing marginal utility explains the slope downward demand curve Willingness to Pay:   The maximum price that a buyer is willing and able to pay for a good Measures how much the buyer values the good or service The Budget Line I = PX X + PY Y I − PX X = PY Y I PX − X =Y PY PY 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 The Budget Line    As we know, income and prices can change As incomes and prices change, there are changes in budget lines We can show the effects of these changes on budget lines and consumer choices The Budget Line - Changes  The Effects of Changes in Income   An increase in income causes the budget line to shift outward, parallel to the original line (holding prices constant) Can buy more of both goods with more income The Budget Line - Changes  The Effects of Changes in Income   A decrease in income causes the budget line to shift inward, parallel to the original line (holding prices constant) Can buy less of both goods with less income The Budget Line - Changes in Income Clothing (units per week) A increase in income shifts the budget line outward 80 60 A decrease in income shifts the budget line inward 40 20 L3 (I = L1 (I = $80) $40) 40 80 120 L2 (I = $160) 160 Food (units per week) The Budget Line - Changes in Price Clothing (units per week) A decrease in the price of food to $.50 changes the slope of the budget line and rotates it outward 40 L3 L2 L1 (PF = 1) (PF = 2) 40 80 120 An increase in the price of food to $2.00 changes the slope of the budget line and rotates it inward (PF = 1/2) 160 Food (units per week) Consumer Choice Consumer Choice   Given preferences and budget constraints, how consumers choose what to buy? Consumers choose a combination of goods that will maximize their satisfaction, given the limited budget available to them Consumer Choice The maximizing market basket must satisfy two conditions: It must be located on the budget line   They spend all their income – more is better It must give the consumer the most preferred combination of goods and services Consumer Choice   Graphically we can see different indifference curves of a consumer choosing between clothing and food Consumer wants to choose highest utility within their budget Consumer Choice 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 at consumer’s optimal consumption point, 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) Note this is ONLY true at the optimal consumption point ...Overview Theories of consumer behavior Explanation of how consumers allocate income to purchase different goods and services (market basket)  Utility Theory  Theory of Consumer Choice... consider savings 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... happier is individual from consuming one more unit of coffee The change in total utility due to a one-unit change in the quantity of a good or service ∆U MU = ∆Q Marginal utility -MU Number of cups