Transcript Lec 11.ppt

Consumer Behavior
• Three steps involved in the study of
consumer behavior
1) Study consumer preferences
• To describe how and why people prefer one good
to another.
2) Turn to budget constraint
• People have limited incomes.
3) Determine consumer choices
• What combination of goods will consumers buy to
maximize their satisfaction?
Consumer Preferences
• A bundle of goods or market basket is a
collection of one or more commodities.
• A market basket may be preferred over
another market basket containing a
different combination of goods.
Three Basic Assumptions of
Consumer Preferences
• Preferences are complete.
– Give me any two baskets of goods (A and B),
I will be able to tell you on of the followings:
• I prefer A to B
• I prefer B to A
• I am indifferent between A and B.
Three Basic Assumptions of
Consumer Preferences
• Preferences are transitive.
– If I prefer A to B and B to C, I must also
prefer A to C.
• Non-satiation: Consumers always prefer
more of any good to less.
Preferences over Market Basket
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
30
40
Food
(units per week)
Indifference Curve
Clothing
(units per week)
B
50
Indifference curves represent all combinations
of bundles that provide the same level of
satisfaction to a person.
H
E
40
Combination B,A, & D
yield the same satisfaction
•E is preferred to U1
•U1 is preferred to H & G
A
30
D
20
U1
G
10
10
20
30
40
Food
(units per week)
Indifference Curve
Indifference curves slope downward to the right.
If it sloped upward it would violate the assumption
that more of any commodity is preferred to less.
Clothing
(units per week)
50
40
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.
B
H
E
A
30
D
20
G
U1
10
10
20
30
40
Food
(units per week)
Indifference Map
An indifference map is a set of indifference
curves that describes a person’s preferences
for all combinations of two commodities.
Clothing
(units per week)
Each indifference curve in the map
shows the market baskets among
which the person is indifferent.
D
B
A
U2
U1
U3
Market basket A
is preferred to B.
Market basket B is
preferred to D.
Food
(units per week)
Indifference Curve
Clothing
(units per week)
U2
Indifference Curves
Cannot Cross
U1
If crossed, the consumer should
be indifferent between A, B and
D. However, B contains more of
both goods than D.
A
B
D
Food
(units per week)
The Amount of Clothing Given up per Unit of
Food Decreases with Food Increase
Clothing
(units
per week)
A
16
Observation:
The amount of clothing given up for
a unit of food decreases from 6 to 1.
14
12
-6
10
B
8
-4
D
6
E
-2
4
G
-1
2
1
2
3
4
5
Food
(units per week)
Marginal Rate of Substitution
Clothing
(units
per week)
A
16
14
12
The marginal rate of substitution
(MRS) quantifies the amount of one
good a consumer will give up to
obtain more of another good
MRS =
6
-6
10
MRS is measured by the
slope of the indifference
curve:
B
1
8
D
6
MRS = 2
F
E
-2
4
MRS   C
1
2
1
2
3
4
5
Food
(units per week)
Diminishing Marginal Rate of Substitution
Clothing
(units
per week)
Along an indifference curve there is a
diminishing marginal rate of substitution.
A
16
14
12
MRS =
6
Indifference curves are convex
because as more of one good
is consumed, a consumer
would prefer to give up fewer
units of a second good to get
additional units of the first one.
-6
10
B
1
8
D
MRS = 2
6
4
=> Consumers like variety.
E
-2
1
2
1
2
3
4
5
Food
(units per week)
Perfect Substitutes
Apple
juice
(glasses)
Perfect
Substitutes
4
3
Two goods are perfect
substitutes when the marginal
rate of substitution of one good
for the other is constant.
2
1
Orange juice (glasses)
0
1
2
3
4
Perfect Complements
Left
Shoes
Perfect
Complements
4
3
Two goods are perfect
complements when
the indifference
curves for the goods
are shaped as right
angles.
2
1
0
1
2
3
4
Right Shoes
Consumer Choice
• Consumers choose a combination of
goods that will maximize the satisfaction
they can achieve, given the limited budget
available to them.
Consumer Choice
• The maximizing bundle 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.
Consumer Choice
Clothing
(units per
week)
Pc = $2
Pf = $1
I = $80
40
Market basket D
cannot be attained
given the current
budget constraint.
D
30
20
U3
Budget Line
0
20
40
80
Food (units per week)
Consumer Choice
Clothing
(units per
week)
Pc = $2
Pf = $1
Point B does not maximize satisfaction
because there exist a point A which is
attainable and yields a higher
satisfaction.
40
30
I = $80
B
Note that the MRS (-(-10/10) = 1 is greater
than the price ratio (1/2).
-10C
A
Budget Line
20
U1
+10F
0
20
40
80
Food (units per week)
Consumer Choice
Clothing
(units per
week)
Pc = $2
Pf = $1
I = $80
At market basket A
the budget line and the
indifference curve are
tangent and no higher
level of satisfaction
can be attained.
40
30
A
At A:
MRS =Pf/Pc = .5
20
U2
Budget Line
0
20
40
80
Food (units per week)
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 that satisfaction
is maximized where:
Benefit of
consuming food
as compared to
cloth.
PF
MRS 
PC
Opportunity
cost of food in
terms of cloth.
• Satisfaction is maximized when the
marginal rate of substitution (of F and C)
is equal to the ratio of the prices (of F
and C).
Example : Tina’s Indifference Curve
INDIFFERENCE CURVES
Figure A11.1 shows an indifference curve and map.
INDIFFERENCE CURVES
In part (a), Tina is equally happy consuming at any point
along the green indifference curve.
INDIFFERENCE CURVES
Point C is neither better nor worse than any other point
along the indifference curve.
INDIFFERENCE CURVES
Points below the indifference curve are worse than points
on the indifference curve—are not preferred.
INDIFFERENCE CURVES
Points above the indifference curve are better than points
on the indifference curve—are preferred.
INDIFFERENCE CURVES
Part (b) shows three indifference curves—I0, I1, and I2—that
are part of Tina’s indifference map.
INDIFFERENCE CURVES
The indifference curve in part (a) is curve I1 in part (b). Tina
is indifferent between points C and G.
INDIFFERENCE CURVES
Tina prefers point J to points C and G. And she prefers C
and G to any point on curve I0.
INDIFFERENCE CURVES
• Marginal Rate of Substitution
– The marginal rate of substitution is the rate at
which a person will give up good y (the good
measured on the y-axis) to get more of good x (the
good measured on the x-axis) and at the same time
remain on the same indifference curve.
– Diminishing marginal rate of substitution is the
general tendency for the marginal rate of substitution
to decrease as the consumer moves down along the
indifference curve, increasing consumption of good x
and decreasing consumption of good y.
INDIFFERENCE CURVES
Figure A11.2 shows
the calculation of the
marginal rate of
substitution.
The marginal rate of
substitution (MRS) is the
magnitude of the slope
of an indifference curve.
First, we’ll calculate the
MRS at point C.
INDIFFERENCE CURVES
Draw a straight line with
the same slope as the
indifference curve at point
C.
The slope of this line is 8
packs of gum divided by 4
bottles of water, which
equals 2 packs of gum per
bottle of water.
INDIFFERENCE CURVES
This number is Tina’s
marginal rate of
substitution. Her MRS = 2.
At point C, when she
consumes 2 bottles of
water and 4 packs of gum,
Tina is willing to give up
gum for water at the rate of
2 packs of gum per bottle of
water.
INDIFFERENCE CURVES
Now calculate Tina’s MRS
at point G.
The red line at point G
tells us that Tina is
willing to give up 4
packs of gum to get 8
bottles of water.
Her marginal rate of
substitution at point G is 4
divided by 8, which equals
1 ⁄2.
INDIFFERENCE CURVES
• Tina’s Equilibrium
– The goal of the Tina is to buy the affordable
quantities of water and gum that make the her
as well off as possible.
– Her preference map describe the way a she
values different combinations of goods.
– Budget and the prices of the water and gum
limit her choices.
INDIFFERENCE CURVES
Figure A11.3 shows
Tina’s equilibrium.
Tina’s indifference curves
describe her preferences.
Tina’s budget line describes the
limits to what she can afford.
Tina’s best affordable point is C.
At that point, she is on her
budget line and also on the
highest attainable indifference
curve.
INDIFFERENCE CURVES
Tina can consume the same
quantity of water at point J
but less gum. She prefers C
to J.
Point J is equally preferred to
points F and H, which Tina
can also afford.
Points on the budget line
between F and H are
preferred to F and H. And of
all those points, C is the best
affordable point for Tina.
INDIFFERENCE CURVES
• Deriving the Demand Curve
– To derive Tina’s demand curve for bottled
water:
• Change the price of water
• Shift the budget line
• Work out the new best affordable point
INDIFFERENCE CURVES
Figure A11.4 shows how to
derive Tina’s demand curve.
When the price of water is $1 a
bottle, Tina’s best affordable
point is C in part (a) and at point
A on her demand curve in part
(b).
When the price of water is 50
cents a bottle, Tina’s best
affordable point is K in part (a)
and at point B on her demand
curve in part (b).
INDIFFERENCE CURVES
Tina’s demand curve in part (b)
passes through points A and B.