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Household Behavior and Consumer Choice
Household Behavior and Consumer Choice
5
Household Behavior and Consumer Choice
Part Three
Chapters 12-15
Market Imperfections and the Role of Government Imperfect market structures Externalities, public goods, imperfect information, social choice Income distribution and poverty
Chapters 6-7 Firm Behavior Choice of technology Supply in output markets Demand in input markets
2002 Prentice Hall Business Publishing
Capital
Perfect Competition
A key assumption in the study of household and firm behavior is that all input and output markets are perfectly competitive.
Perfect competition is an industry structure in which there are many firms, each small relative to the industry, producing virtually identical (or homogeneous) products and in which no firm is large enough to have any control over price.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Perfect Knowledge
We also assume that households and firms possess all the information they need to make market choices.
Perfect knowledge is the assumption
that households posses a knowledge of the qualities and prices of everything available in the market, and that firms have all available information concerning wage rates, capital costs, and output prices.
output, to demand.
2. How much labor to supply.
3. How much to spend today and
OPTION
RENT
FOOD
EXPENSES
TOTAL
AVAILABLE?
A B C D
The real cost of a good or service is its opportunity cost, and opportunity cost is determined by relative prices.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
I X . PX Y. P Y
where:
I = consumers income X = quantity of good X purchased Y = quantity of good Y purchased PX = price of good X PY = price of good Y
Principles of Economics, 6/e Karl Case, Ray Fair
I X . PX Y. P Y
I X . PX Y . PY I X . PX Y PY PY I PX Y X PY PY
PX PY
One of the possible combinations is 5 Thai meals and 10 Jazz club visits per month.
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
Marginal utility is the additional satisfaction gained by the consumption or use of one more unit of something.
MU X MU Y PX PY
where: MUX = marginal utility derived from the last unit of X consumed. MUY = marginal utility derived from the last unit of Y consumed. Y = quantity of Y purchased PX = price of good X PY = price of good Y
Principles of Economics, 6/e Karl Case, Ray Fair
2 3 4 5 6
(1) BASKETBALL GAMES PER WEEK 1 2 3 4 5 6
2002 Prentice Hall Business Publishing
22 28 32 34 34
(2) TOTAL UTILITY 21 33 42 48 51 51
10 6 4 2 0
(3) (MU) 21 12 9 6 3 0
with each additional unit consumed, so people are not willing to pay as much.
falls, a consumer has more purchasing power with the same amount of income.
When the price of a product
rises, a consumer has less purchasing power with the same amount of income.
When the price of a product rises, that product becomes less attractive relative to potential substitutes.
FALLS
Opportunity cost of the good falls Substitution effect Household buys more
Income effect
RISES
Opportunity cost of the good rises
2002 Prentice Hall Business Publishing
Substitution effect
Consumer Surplus
Consumer surplus is the difference between the maximum amount a person is willing to pay for a good and its current market price. Consumer surplus measurement is a key element in costbenefit analysis.
household
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The labor supply curve is a diagram that shows the quantity of labor supplied at different wage rates. Its shape depends on how households react to changes in the wage rate.
The income effect of a higher wage means that households can now afford to buy more leisure.
When the income effect outweighs the substitution effect, the result is a backward-bending labor supply curve.