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Demand &
Consumer Behavior Chapter 5
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Topics
• Choice & utility theory
– Cardinal utility
– Ordinal utility
– Demand theory
• From individual to market demand
• Applications – Economics o addiction
– !arado" o value
–Consumer surplus
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Chapter 5
Table 5-1
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The #a$ o Diminishin%
ar%inal 'tility
Chapter 5
Figure 5-1
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Derivin% the demand curve
• 'tility ma"imi(ation – )asic premise
• E*uimar%inal principle –
– E*ual mar%inal utilities per peso or every%ood
– +eeded or utility ma"imi(ation
• !rice and *uantity demanded – inverserelationship
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E*uimar%inal !rinciple
.....2
2
1
1==
P
MU
P
MU good good
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arket demand
• arket demand, hori(ontal sum oindividual demand curves
•Demand shits – -ncome chan%es
• +ormal %oods
• -nerior %oods
– .u)stitutes & complements
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arket Demand Derived rom
-ndividual Demands
Chapter 5
Figure 5-2
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Demand Curve .hits $ith Chan%es
in -ncome or in Other /oods0 !rices
Chapter 5
Figure 5-3
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1ey concepts
• .u)stitution eect
• -ncome eect
• Elasticity – !rice elasticity
– -ncome elasticity
• .u)stitutes• Complements
• -ndependents
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.ome applications
• Economics o addiction
• !arado" o value
• Consumer surplus
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Chapter 5
Table 5-2
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Demand or Addictive .u)stances
)y 2ard3Core 'sers
Chapter 5
Figure 5-4
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Demand or Addictive .u)stances
)y Casual 'sers
Chapter 5
Figure 5-5
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Because o Diminishin% ar%inal 'tility4
Consumer0s .atisaction E"ceeds hat -s !aid
Chapter 5
Figure 5-6
C
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Total Consumer .urplus -s the Area under
the Demand Curve and a)ove the !rice #ine
Chapter 5
Figure 5-7
Ch 5
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Chapter 5
Table 5-3
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Economic 6ationality
• The principal )ehavioral postulate is that adecisionmaker chooses its most preerredalternative rom those availa)le to it7
• The availa)le choices constitute thechoice set7
• 2o$ is the most preerred )undle in thechoice set located8
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6ational Constrained Choice
x1
x2
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6ational Constrained Choice
x1
x2Utility
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6ational Constrained Choice
Utility x2
x1
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6ational Constrained Choice
x1
x2
Utility
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6ational Constrained Choice
Utility
x1
x2
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6ational Constrained Choice
Utility
x1
x2
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6ational Constrained Choice
Utility
x1
x2
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6ational Constrained Choice
Utility
x1
x2
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6ational Constrained Choice
Utility
x1
x2
Affordable, but not
the most preferred
affordable bundle.
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6ational Constrained Choice
x1
x2
Utility
Affordable, but not
the most preferred
affordable bundle.
The most preferred
of the affordablebundles.
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6ational Constrained Choice
x1
x2
Utility
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6ational Constrained Choice
Utility
x1
x2
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6ational Constrained Choice
Utility
x1
x2
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6ational Constrained Choice
Utilityx
1
x2
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6ational Constrained Choice
x1
x2
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6ational Constrained Choice
x1
x2
Affordable
bundles
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6ational Constrained Choice
x1
x2
Affordable
bundles
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6ational Constrained Choice
x1
x2
Affordable
bundles
More preferred
bundles
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6ational Constrained Choice
Affordablebundles
x1
x2
More preferred
bundles
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6ational Constrained Choice
x1
x2
x1*
x2*
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6ational Constrained Choice
x1
x2
x1*
x2*
(x1*,x2*) is the mostpreferred affordable
bundle.
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6ational Constrained Choice
• The most preerred aorda)le )undle iscalled the consumer0s O6D-+A69DEA+D at the %iven prices and )ud%et7
• Ordinary demands $ill )e denoted )y":;<p:4p=4m> and "=;<p:4p=4m>7
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6ational Constrained Choice
• hen ":; ? @ and "=; ? @ the demanded
)undle is -+TE6-O67
• - )uyin% <":;4"=;> costs m then the
)ud%et is e"hausted7
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6ational Constrained Choice
x1
x2
x1*
x2*
(x1*,x2*) is interior.
(x1*,x2*) exhausts the
budget.
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6ational Constrained Choice
x1
x2
x1*
x2*
(x1*,x2*) is interior.(a) (x1*,x2*) exhausts the
budget p1x1* ! p2x2* " m.
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6ational Constrained Choice
x1
x2
x1*
x2*
(x1*,x2*) is interior .(b) The slope of the indiff.
#ur$e at (x1*,x2*) e%uals
the slope of the budget #onstraint.
Appendix 5A
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-ndierence Curves or a !air o
/oods
Figure 5A-1
Appendix 5A
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A Family o -ndierence Curves
Figure 5A-2
Appendix 5A
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-ncome Constrains Consumer
.pendin%
Figure 5A-3
Appendix 5A
Fi 5A 4
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Consumer0s ost !reerred andFeasi)le Consumption Bundle -s
Attained at B
Figure 5A-4
Appendix 5A
Fi 5A 5
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Eect o -ncome Chan%e on
E*uili)rium
Figure 5A-5
Appendix 5A
Fi 5A 6
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Eect o !rice Chan%e on
E*uili)rium
Figure 5A-6
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