Topic 4 Final
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Transcript of Topic 4 Final
TOPIC: THEORY OF CONSUMER BEHAVIOR
1. Consumer behavior: hypotheses and determinants.
2. Utility and its types. The laws of Gössen.
3. Indiference curves and their properties.
4. The buget line and consumer equilibrium.
5. „Income-consumption” curve and Engel curve.
6. „Price-consumption ” curve and individual demand curve.
The most important goal of Consumer as economic agent is to maximize the satisfaction of his or her needs through consumption of goods purchased for a certain (limited) income.
In reality, the consumers have to choose the basket of consumer goods from a variety of goods on the market.
In other words, consumers are facing the problem of choice.
In the process of free choice, consumers will take the following interrelated decisions:
1. What to buy? (to choose a market basket with preferable goods - goods with the highest utility);
2. How much to buy? (to analyze the existing market price);
3. Is it possible to buy the goods? (to compare disposable income with price and preferences).
• Determinants of consumers’ choice
• - Preferences,
• - Income,
• -The utility of the purchased goods,
• -The price of the purchased goods,
• - Prices of other goods,
• - Fashion
• -others
• Conclusion:The complexity of choice of consumer
Hypotheses of consumers’ choice are following:
Freedom of decision and action of a consumer
Consumer rationality
Consumer sovereingty
Limited consumer’s income
Subjective utility assessment and the tendency for its maximization
Utility is initial category in the theory of consumer behavior.
In order to make some decisions about market basket, first of all a rational consumer will analyze the utility.
The most preferable market basket gives the highest level of satisfaction, or utility to a consumer.
Utility of a good or service reflects the consumers’
satisfaction which he expects to obtain.
.
•In assessing the utility historically there were two approaches:
•Cardinal (classical) approach
•Ordinal (neoclassical) approach
position of cardinal theory:
• subjective, individual assessment of utility
• quantitative measuring of utility using a conventional unit - "utile”
• the principle of diminishing marginal utility( the first law of of Gössen);
• the rule of maximizing utility(the second law of of Gössen).
Types of utility:Total utility is the total satisfaction received from
consuming an amount of goods.The utility function has the following form:
Marginal utility is the extra utility received from consuming one additional unit of the good.
The Formula for calculation of Marginal utility is:
To be expressed in mathematical term, the MU can be defined as the partial derivative of the 1-st grade of utility function: MU(Qx) = (TUx)'.
iXQfTU
i
i
XX Q
TUQMU
While consuming a quantity of a good, the changes in MU and TU are interdependent.
Consumed quantity of a
specific good Qx
Total utility (utile) TUx
Marginal utility (utile) Mux
0 020
15
10
5
0
-5
1 20
2 35
3 45
4 50
5 50
6 45
Qx (quantity)
Util
ity (T
ux, M
Ux)
Analyzing the evolution of TU and MU we can draw the following conclusions:
1. As an additional unit of a given good is consumed MU decreases and TU will increase, but each time at a lower rate.
2. In the point of satiety, the marginal utility is zero (MUx=0), and total utility reaches its highest level (TUx=50 utile), respectively Qx=5 units is the optimal amount of consumption.
3. If consumption continues, MU becomes negative and total utility decreases.
• The law of diminishing marginal utility(the first law of Gössen)
• The law of diminishing marginal utility states that as the amount of a commodity consumed increases, the marginal utility of the last unit consumed tends to decrease:
МU Х1 > МU Х2 … > МU Хi
where МU Хi - marginal utility of commodity i (1, 2, 3….)
Each consumer tends to maximize the total utility from consumption of purchased goods. Meanwhile the consumer is interesed in eficient use of his financial resourses. Which principles will a rational consumer follow?
In microeconomics this principle reflects the utility-maximizing rule ( the second Law of Gössen).
The second Law of Gössen assumes, that in order to maximize utility, consumer allocate money income in such a way, that the last dollar spent on each product purchased yields the same amount of marginal utility:
Z
Z
Y
Y
X
X
P
MU
P
MU
P
MU ...
Marginal utilities (MU) of Goods and MU/P
Amount of consumed goods (Q)
Juice Pizza
MU MU/P MU MU/P
1234567
6543210
6/10=0,60,50,40,30,20,10
10875431
10/20=0,50,4
0,350,250,2
0,150,05
Using the II law of Gössen, determine the optimal combination of Juice and Pizza, if income of a student is 70 m. u., and price of one unit of juice equals to 10 m.u., price of pizza is 20 m.u.
position of Ordinal theory:- ranking market basket (A, B, C) in terms of
their preference and the utility for the consumer. - introduction of research tools: - a) the indifference curve,- b) marginal rate of substitution, and - c) the budget line;
- maximizing utility by choosing the most preferable market basket (using fully consumer’s income in conditions of actual prices).
The ordinal theory of consumer behavior starts from a series of assumptions about the nature of consumer’s preferences:
1.Assumption of comparison and ranking of consumer’s preferences: between two market basket A and B, he will choose one of three possible alternatives:
*would prefer A to B, (A B);
* Would prefer B to A, (B A);
*is indifferent towards the two market
basket, considering them to be
equivalents, (A ~ B).
Prefered relations
Indiferent relations
2.The consumer’s preferences are transitive: consumer ranks different
market basket and compares them in
pairs:
if A B and B C → A C .
3.The consumer always prefers more to less: if A (X, 2Y) and B (X, Y): A B.
In the theory of consumer behavior indifference curves provide a ranking of the individual’s preference.
Indifference curve shows alternative combinations of two economic boons, that give the consumer equal utility (TU) or satisfaction.
An indifference curve is the set of points representing market basket among which the concumer is indifferent.
Cola
Cake
A
B
CD
Marketbasket
X (Cola, un.)
Y (cake, un.)
abcd
1268
8621
Alternative market basket
X
6
8
0
12
10
1 2 6 8
What is preferable ?
Indifference curve
Y
An indifference map is a graph of the entire set of indifference curves, each one farther away from the origin, corresponding to increasing levels of total utility.
B
C
A
X
U3
U2
U1
XB XC XA
YC
YB
YA
What is preferable ?
Properties of indifference curves:
1. Indifference curve situated further from the origin, coresponds to a higher level of utility and is more preferable for consumer, meaning: U1 < U2 < U3
2. Indifference curves can never intersect.
A
C
B
X
Y
U1
U2
XB XC
YB
YC
3. Indifference curve are usually negatively sloped and are convex to the origin. A
B
C
D
X (pears)
Y (apples)
∆X
∆Y
Economists use the term of Marginal rate of substitution of goodY for good X – MRSxy , which means the “level” till which the substitution of one good for another is justified.
Marginal rate of substitution is the amount of one good that an individual is willing to give up in order to get one more unit of another good and while maintaining the same level of total utility:
X
Yxy Q
QMRS
TU – const.
y
xxy MU
MUMRS
or
U1
U2
X
YSpecial cases of indifference curves
X
Y
U1U2
U3U4
U5
U1 U2 U3
X
Y
X
Y
A
B
H
K
0
I/Py
I/Px
The budget line is a set of alternative combinations of quantity of good X and Y that the consumer can buy.
What is attainable ?
The budget line equation can be represented as follows:
YyXx QPQPI To draw a straight line is sufficient to know its two extreme points:
Xy
x
yr Q
P
P
P
IQ y
x
y
xx Q
P
P
P
IQ
The slope of the budget line in absolut value is the tangent of the angle ABO of triangle AOB (figure 11):
Py
Px
PxI
PyI
OB
AOtgABO
E
B
C
D
M
F0 1 2 3 4 5 6
(I/Px ,O)
A
X
2
4
6
8
10
Y
N
(O,I/Py)
Cake
Cola
Cake
Cola
7
10
14 J
A
M
N F K
I =30 lei
I ↑=42 lei
I2 ↓=21 lei
753,5
X
Y a) Consequences of changes in consumers disposable income
I, Px, Py – constant (Px=6 lei, Py=3 lei) The budget line will shift
up (to the right), paraleel to the original line (figure 13).
X
Y
Cola
Cake
A
F5
H
10
10
Px =3 lei
Px =6 lei Px
b) Consequences of changing of price of good X (Px) I, Py – constant
1.A decrease in the price of good X (Px↓), ceteris paribus, leads to decrease of the slope of buget line in the absolut value.
X
Y
A
FN
10
52,5
Px =6 lei
Px =12 lei
Px
Cake
Cola
2. As the price of good X rises (Px↑), the absolute value of the slope of a buget line increases comparativ to the absolute value of the slope of initial budget line
Px↑; I – constant; Py – constant
Consumer equilibrium. Consumer reaches equilibrium state, when he fully uses his disposable income and maximizes satisfaction from the consumption of a set of goods (X,Y).
Rational consumer choice can be summarized in the following table:
QUESTION PROBLEMGRAPHICAL
INTERPRETATION
What want consumers?
PrefferencesIndifference Map
What can consumers?
Constraints Budget line
What do consumers?
optimal choice of consumer
Point of equilibrium of consumer
Graphic, the point where the budget line is tangent to the highest attainable indifference curve determines the equilibrium (optimum) of consumer. At this point, the slope of indifference curve (reflects the -MRSxy) equals to the slope of the budget line (is --Px / Py):
y
y
x
x
y
x
y
x
y
x
y
x
P
MU
P
MUsau
P
P
MU
MU
P
P
MU
MU
The consumer’s equilibrium condition requires that the ratio of marginal utilities of goods X and Y is equal to the prices ratio.
Cola
a
E
cd
Cake
A
F X
Y
8
6
21
10
50 1 2 8
U1
U2
U3
Equilibrium point of consumer is affected by changes in disposable income and commodity prices.
The case of change of consumer disposable income. The sensitivity of consumer equilibrium to income changes can be described by drawing two curves: “income-consumption” curve and Engel’s curve.
1. An increase in the consumer income (I↑), moves the budget line parallel to itself to the right and consumer equilibrium point E0 moves to right (up) to the point E2.
2. A decrease in the consumer income (I↓), moves the budget line parallel to itself to the left and consumer equilibrium point moves to the left (down) to the point E1.
X
Y
E1
E0
E2
0X
I
I1
I0
I2
E2
E0E1
I
U1
U2
U3
I
A
B
C
D N
M
X0X1 X2
X0X1 X2
“Income-consumption” is the unity of consumer optimum points E0, E1, E2 corresponding to all possible levels of money income, ceteris paribus.
Engel’s curve (E. Engel (1821-1896) is derived from the „income-consumption” curve and shows the amount of a good that the consumer would purchase per unit of time at various income levels.
X
Y
U3
U2
U1
O
The positioning trajectory of “ income-consumption” curve and the Engel curve is influenced by the nature of the consumption goods.
For primary necessity goods, curve is very steep and close to the OY axis.
10 d
I
X
Y
U1
U2
U3
O
For luxury goods, curve is close to the axis OX
1Ed
I
X
Y
U1
U2
U3
O
For inferior goods, 0Ed
I
X
Y
U1
U2
U3
For neutral goods, . “Income-consumption” curve is a vertical line.
0Ed
I
Cloth
House
Food
Con
sum
ptio
n
exp
endi
ture
s
Income of households
Christian Engel was a XIX-th century German statistician who did pioneering work related to such curves,which are important for studies of family expenditure patterns. Looking to Engel the family expenditures for food will rise in less degree than income increases. The higher the proportion of income spent on food in a nation, the poorest the nation is taken to be.
Agrement 1,9Comunicaţii
4,7Transport
4,5
Sănătate5,9
Dotarea locuinţei 3,7
Întreţinerea locuinţei
15,3
Învăţământ0,5
Hoteluri, restaurante
2,3
Încălţăminte, îmbrăcăminte
11,6
Băuturi alcoolice, tutun
1,9
Produse alimentare
43,7Diverse
3,9
0 10 20 30 40 50 60 70 80
Tanzania
Madagascar
Vietnam
Sierra Leone
Indonezia
Moldova
ţările cu venituri joase:
Argentina
Mexic
Rusia
Thailand
Brazilia
ţările cu venituri medii:
Danemarca
Marea Britanie
Canada
SUA
Japonia
ţările cu venituri înalte:
The part of expenditures for food in the family budget
in %.
The CASE OF A CHANGE IN THE PRICE OF A GOOD, CETERIS PARIBUS:
a)IF Px↑, the absolute value of the slope of the budget line increases and the budget line will change its initial position from AB to AC, and the point of equilibrium will move from E0 to E1.
b)If Px↓, the absolute value of the slope of the budget line decreases and the budget line will change its initial position from AB to AD, and the point of equilibrium will move from E0 to E2.
X
Y
P1
P0P2
Y1
Y2
Y0
E1
E0
E2
X1 X0 X2
U1 U2 U3
D
A
BC
E1
E0
D
X1 X0 X2
E2
THE SUBSTITUTION AND INCOME EFFECT in the case of NORMAL GOODS
Total effect of changes in the price of a good can be divided into two effects: the income effect and substitution effect.
The substitution effect measures the increase in the quantity demanded of a good when its price falls resulting only from the relative price decline and independent of the change in real income. If the price of good X decreases, the consumer substituites good Yby good X, purchasing less of the good Y and more of good X, moving to another point on the Same indifference curve.
The income effect measures the increase in the quantity purchased of a good resulting from the increase in real income and purchasing power of a consumer that accompanies a price decline. This effect involves the movement from initial indifference curve to another curve. The income effect depends on the nature of the goods.
Cola
Cake
1 2 3 4 5 6 7 98 10
123
456789
10A
H
b
v
k
M
F N
I=30 leiPx=6 lei
I=21 leiPx=3 lei
I=30 leiPx=3 lei
Y
X
Surplus of consumer
Paradox of A. Smith „diamants – water”
The Value of time
Cash and noncash gift-giving
Application of the theory of consumer behavior:
0 01 2 3 4 5 6 1 2 3 4 5 6
1 1
2 2
3 3
4 4
5 5
66
7 7
8 8
9 9
10 10
Price Price
Access to Internet (hour) Acces to Internet (hour)
DD
Market price
Surplus of consumer
Surplus of consumer
a) Individual demand b) Market demand