Economics of Food

Theory of Consumer Behaviour

(chapter 2)
Dr. Chenguang Li

1
 Learning Outcomes
At the end of the lecture, you should be
able to…
• Explain the basic logic of choices using economics
concepts and tools (eg. utility and indifference curves…)
• Describe what influences consumers’ decisions
• Derive a budget constraint and explain the effect of
price and income changes
 Utility
• We will assume that consumers are rational
individuals who maximize their satisfaction or
utility.

What are the choices to make…?

 Utility Function
• A utility function is an algebra expression that
allows us to rank a consumption bundle by the
total utility or satisfaction it provide.

U = f ( x1, x2, x3… )

Let’s start with one commodity case first….
 Total and marginal utility
Table 3–2 Quantity of Hamburgers Consumed per Week

Quantity of Hamburgers Total Utility Marginal Utility

Consumed per Week
1 20
2 30
3 39
4 47
5 54
6 60
7 65
8 69
9 72
10 74
11 74
12 70
Total utility continues to increase as the number of hamburgers consumed increases, at
least up to 11 hamburgers. At this point, total utility is maximized. Beyond 11
hamburgers, total utility decreases.
 Marginal Utility
• Marginal utility is the change in
utility derived from an increase in
consumption of a particular good.

MUhamburgers = Δ utility ÷ Δ hamburgers

 Marginal Utility
• Marginal utility is the change in
utility derived from an increase in
consumption of a particular good.

MUhamburgers = Δ utility ÷ Δ hamburgers

• This value will fall as consumption

increases.
Marginal utility declines as Sue increases her consumption of hamburgers.
Marginal utility goes to zero at the peak of the total utility curve
Law of diminishing marginal utility

• As consumption per unit of time

increases, marginal utility decreases.

• Because there is so much truth to

this notion, it has been given law-like
status.
 Question?
• Can we assume that the marginal utilities
provided by different commodities are
independent?

• When you have other choices, what will

happen to your satisfaction and preference?
Tacos or Hamburgers?
Cardinal vs ordinal measurement
• Cardinal measurement of utility is
both unreasonable and unnecessary.

• We can instead use an ordinal

measurement of utility, which means
all we need to know is that one
bundle is preferred over another.
 Indifference Curves
• Modern consumption theory is based
upon the notion of isoutility curves,
where "iso" is the Greek for "equal".

• The consumer is assumed to be

indifferent among different
combinations of goods along a
isoutility curve.
An indifference curve represents all combinations of two goods that yield an equal level of
satisfaction or utility. In other words, the total utility derived from consumption is equal at all points
along an indifference curve.

Compare…

1. The utility at point

M and point Q?

1. The utilities for the

indifference curve
I2 and I7.
 Indifference Curves

The two indifference curves here can be thought of as providing 200 and 700 units of
utility.
 Indifference Curves

One would normally expect a number of additional isoutility or indifference curves.

Slope of Indifference Curve
• The slope of an indifference curve is
known as the marginal rate of
substitution (MRS). The marginal
rate of substitution of hamburgers
for tacos is given by:

MRS = Δ tacos ÷ Δ hamburgers

Slope of Indifference Curve

MRS = Δ tacos ÷ Δ hamburgers

• Interpretation:
The The marginal rate of substitution of
hamburgers for tacos reflects the number
of tacos a consumer is willing to give up
for an additional hamburger while
maintaining the same level of utility.
The MRS between points M and Q is equal to:_____________________

MRS = Δ tacos ÷ Δ hamburgers

The MRS between points M and Q is equal to: −2.0 = −2 ÷ 1.0

But what does it mean? (interpretation)

This means the consumer is willing to give up 2 tacos in exchange for one additional
hamburger!
Which bundle would you prefer more…bundle M or bundle Q?
The answer is that we would be indifferent because they give us the same utility. The
ultimate choice will depend on the prices of these two products.
What about the choice between bundle M and bundle P?
We would prefer bundle P over bundle M because it gives us more utility or satisfaction.
The question is whether we can afford to buy 5 tacos and 5 hamburgers!
But…We haven’t talked about prices so far
 Price -- Tacos or Hamburgers

Price of Hamburger

PHAMBURGERS = $ 1.25 each

Price of Taco

PTACOS = $ 0.5 each

You have $5 budget for fast food

 Example of a Budget Constraint

Table 3–3 Example of a Budget Constraint

• Each of these combinations represent a point on the budget line…

 Concept of Budget Constraint
• Weekly budget for fast food:
PHAMBURGERS × QHAMBURGERS + PTACOS × QTACOS

where PHAMBURGERS and PTACOS represent the current

price of hamburgers and tacos

while QHAMBURGERS and QTACOS represent the

quantities you plan to consume during the week.
 Original budget line

Taco consumption per week 20

15

10 B

5 C

2 4 6 8
Hamburger consumption per week
 Concept of Budget Constraint
• The budget constraint limits the amount
that you can be spent on these items. A
graph depicting this constraint is referred
to as the budget line. The slope of this line
is given by:

Slope of budget line = −(PHAMBURGERS ÷ PTACOS)

 What if Income changes?
Doubled? Halved?
Taco consumption per week 20

15

10 B

5 C

2 4 6 8
Hamburger consumption per week
 Income changes
Changes in income
Taco consumption per week
20 E

15

10 B

Doubling
5 F
Halving
G A D
2 4 6 8
Hamburger consumption per week
 What if price of Taco changes?

20
Taco consumption per week

15

10 B

5 C

2 4 6 8
Hamburger consumption per week
 Taco price changes
C
Taco price changes
20 E
Taco consumption per week

15

10 B Halving

5 F
Doubling

A
2 4 6 8
Hamburger consumption per week
 What if price of Hamburger changes?

20
Taco consumption per week

15

10 B

5 C

2 4 6 8
Hamburger consumption per week
Figure 3–4 Let the line connecting points A and B represent the original budget
constraint or budget line. This line suggests that Carl Consumer could spend his entire
weekly budget of $5 to buy 4 hamburgers costing $1.25 each, 10 tacos costing $0.50
each, or some combination of these two food items that appears along line AB.
Line BA is the original budget line. It says that Carl can afford either 10 tacos or two
hamburgers a week with his $5 weekly budget.
The original budget line would shift in to line FG if Carl’s available income fell in half (or
both prices doubled). It would shift out to line ED if Carl’s income doubled (or both
prices fell in half).
The budget line would shift out to line AE if the price of tacos fell in half or shift in to line
AF if taco prices fell in half. Note the price of hamburgers did not change!
Finally, the budget line would shift out to line BD if the price of hamburgers fell in half, or
in to line line BG if the price of hamburgers doubled.
 In Summary
• Consumers rank preferences based upon
utility or the satisfaction derived from
consumption
• Businesses spend millions of dollars on
product research to satisfy consumer
needs
• A budget constraint limits the amount we
can buy in a particular period
• Price is therefore important
 References
• Penson et al. (2015). Introduction to
Agricultural Economics, Chapter 3.