Chapter-4:

The Theory of Individual Behaviour

by Traheka Erdyas Bimanatya, M.Sc.

Managerial Economics | 22 March 2019

Outline
―Theoretical Approach to Consumer Behaviour
▪ Indifference Curve and Its Assumptions
▪ Budget Constraint
▪ Comparative Statics
― Applications of Indifference Curve
▪ Buy One, Get One Free
▪ Income-Leisure Choice
▪ Individual Demand and Market Demand Curves

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PART 1:
THEORETICAL APPROACH TO
CONSUMER BEHAVIOUR
Who is consumer?
An individual who purchases good and services from firms for the
purpose of consumption.

Consumer opportunities Consumer preferences

Set of possible goods and services Determine which set goods and
consumers can afford to consume. services will be consumed.

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What assumptions do we have? #1

▪ Property 1- Completeness
For any two bundles of goods either:
𝐴 ≻ 𝐵.
𝐵 ≻ 𝐴.
𝐴 ∼ 𝐵.

▪ Property 2- More is better

If bundle 𝐴 has at least as much of every
good as bundle 𝐵 and more of some
good, bundle 𝐴 is preferred to bundle 𝐵.

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What assumptions do we have? #2
▪ Property 3- Diminishing marginal rate of
substitution
As a consumer obtains more of good X, the
amount of good Y the individual is willing to
give up to obtain another unit of good X
decreases.

▪ Property 4- Transitivity
For any three bundles, 𝐴, 𝐵, and 𝐶, either:
If 𝐴 ≻ 𝐵 and 𝐵 ≻ 𝐶, then 𝐴 ≻ 𝐶.
If 𝐴 ∼ 𝐵 and 𝐵 ∼ 𝐶, then 𝐴 ∼ 𝐶.
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What is budget constraint? #1
Restriction set by prices and income that limits bundles of goods
affordable to consumers.
▪ Budget set:

𝑃𝑋 𝑋 + 𝑃𝑌 𝑌 ≤ 𝑀

▪ Budget line:

𝑃𝑋 𝑋 + 𝑃𝑌 𝑌 = 𝑀
Market rate of
𝑀 𝑃𝑋 substitution
𝑌= − 𝑋
𝑃𝑌 𝑃𝑌

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What is budget constraint? #2
Changes in Income Changes in Prices

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What is consumer equilibrium ?
Consumption bundle that is affordable and yields the greatest
satisfaction to the consumer.

▪ When in consumer equilibrium:

𝑃𝑋
– 𝑀𝑅𝑆 =
𝑃𝑌

▪ Price and income changes will lead to

consumer equilibrium changes
(comparative statics).

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Comparative Statics: Changes in price
Y is a substitute for X Y is a complement for X

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Comparative Statics: Changes in income
Normal Good Inferior Good

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Moving from one equilibrium to another when the price of one good
changes can be broken down into two effects:

▪ Substitution effect (A to B):

The movement along a given indifference
curve that results from a change in the
relative prices of goods, holding real
income constant.

▪ Income effect (B to C):

The movement from one indifference curve
to another that results from the change in
real income caused by a price change.

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Q & A #1
ANY QUESTIONS UP TO THIS
POINT?
PART 2:
APPLICATIONS OF
INDIFFERENCE CURVE
Consumer Case: Buy One, Get One Free

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Worker Case: Income-Leisure Choice

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Deriving Individual Demand
and Market Demand Curves #1

Indifference curves along with price

changes determine individuals’
demand curves

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Deriving Individual Demand and Market Demand Curves #2
Market demand is the horizontal summation of individuals’ demands.

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Q & A #2:
ANY QUESTIONS UP TO THIS
POINT?
 THANK YOU
Traheka Erdyas Bimanatya, M.Sc. traheka.erdyas.b@ugm.ac.id

Traheka Erdyas Bimanatya