Transcript Ch 4. The Theory of Individual Behavior

Ch 4. The Theory of Individual
Behavior
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Consumer Behavior

Assume 2 goods exist in the economy.

Assume a consumer is able to order his
or her preferences for alternative bundles
or combinations of goods from best to
worst.
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Consumer Behavior

A>B
the consumer prefers bundle A to bundle
B.

A–B
the consumers view the two bundles as
equally satisfying. He or she indifferent
between bundles A and B.
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Consumer Behavior

The preference ordering is assumed
to satisfy four basic properties:
1. Completeness.
2. More is better.
3. Diminishing marginal rate of
substitution.
4. Transitivity.
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Consumer Behavior

Completeness:
- for any two bundles, say A and B,
either A > B, B > A, A – B.
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Consumer Behavior

More is better:
- for any two bundles, say A and B,
either A > B, B > A, A – B.
Figure 4-1 Page 120.
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Consumer Behavior

Diminishing marginal rate of
substitution:
- As a consumer obtains more of good
X, the rate at which he or she is
willing to substitute good X for good
Y decreases.
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Consumer Behavior

Transitivity:
- For any three bundles, A, B, and C,
if A > B and B > C, then A > C.
Similarly A – B, and B – C, then A - C
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The Budget Constraint

Budget set:
The bundles of goods a consumer can
afford.
Px X + Py Y equals or less M
The budget set.
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The Budget Constraint

Budget line:
The bundles of goods that exhaust a
consumer’s income.
Px X + Py Y = M
The budget line.
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Changes In Income

Changes in income shrink or expand
opportunities.
Figure 4-5 Page 126.
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Changes In Prices

Figure 4-6 Page 127.
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Consumer Equilibrium

The objective of the consumer is to choose
the consumption bundle that maximizes his
or her utility, or satisfaction.

Consumer equilibrium:
The affordable bundle that yields the
greatest satisfaction to the consumer.
Figure 4-8 Page 128.
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Consumer Equilibrium

Consumer equilibrium:
MRS = (Px / Py)
MRS = marginal rate of substitution
Px = price of good X
Py = price of good Y
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Comparative Statics
(Price Changes and Consumer Behavior)

A change in the price of a good will lead
to a change in the equilibrium
consumption bundle.
Figure 4-9 Page 130.
Change in consumer equilibrium due to a
decrease in the price of good X (Note:
that good Y is a substitute for good X).
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Comparative Statics
(Price Changes and Consumer Behavior)
Figure 4-10 Page 131.
When the price of good X falls, the
consumption of complementary good Y
rises.
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Comparative Statics
(Income Changes and Consumer Behavior)
Figure 4-11 Page 132.
An increase in income increases the
consumption of normal goods.
Figure 4-12 Page 133.
An increase in income decreases the
equilibrium consumption of good X (an
inferior good).
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Conceptual and Computational
Questions
1.
A consumer has $400 to spend on
goods X and Y. The market prices of these two goods
are Px = $10 and Py = $40.
1.a. Illustrate the consumer’s opportunity set in a
carefully labeled diagram.
1.b. Show how the consumer’s opportunity set
changes if income increases by $400. How
does the $400 increases in income alter the
market rate of substitution between goods X
and Y?
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Conceptual and Computational
Questions
2.
A consumer must divide $250 between the
consumption of product X and product Y. The
relevant market prices are Px=$5 and Py=$10.
2.a. Write the equation for the consumer’s
budget line.
2.b. Illustrate the consumer’s opportunity set in a
carefully labeled diagram.
2.c. Show how the consumer’s opportunity set
changes when the price of good X increases
to $10?
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Conceptual and Computational
Questions
3.
A consumer is in equilibrium at point A in the accompanying
figure (Figure at page 148). The price of good X is $5.
3.a. What is the price of good Y?
3.b. What is the consumer’s income?
3.c. At point A, how many units of good X does
the consumer purchase?
3.d. Suppose the budget line changes so that the
consumer achieves a new equilibrium at
point B. What change in the economic
environment led to this new equilibrium? Is
the consumer better off or worse off as a
result of the price change?
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