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Economics Chapter - 3 Mark
Economics Chapter - 3 Mark
Consumer
Behavior
Topics to be Discussed
Consumer Preferences
Budget Constraints
Consumer Choice
Revealed Preferences
A change in income
Taxes, etc.
Inferior Good
Substitutes
Complements
A 20 30
B 10 50
D 40 20
E 30 40
G 10 20
H 10 40
A
30
D
20 G
10
Food
10 20 30 40 (units per week)
Chapter 3: Consumer Behavior Slide 29
Consumer Preferences
Clothing Combination B,A, & D
(units per week) yield the same satisfaction
50 B •E is preferred to U1
•U1 is preferred to H & G
H
40 E
A
30
D
20 U1
G
10
Food
10 20 30 40 (units per week)
Chapter 3: Consumer Behavior Slide 30
Consumer Preferences
Indifference Curves
Indifference curves slope downward to the
right.
If it sloped upward it would violate the
assumption that more of any commodity
is preferred to less.
Indifference Curves
Any market basket lying above and to the
right of an indifference curve is preferred to
any market basket that lies on the
indifference curve.
Indifference Curves
Finally, indifference curves cannot cross.
Thiswould violate the assumption that
more is preferred to less.
B A
U3
U2
U1
Food
(units per week)
Chapter 3: Consumer Behavior Slide 35
Consumer Preferences
Clothing Indifference Curves
(units per week) U1 Cannot Cross
U2
B
D
Food
(units per week)
Chapter 3: Consumer Behavior Slide 36
Consumer Preferences
10 B
1 Question: Does this
8 -4 relation hold for giving
D up food to get clothing?
6 1
-2 E
4 G
1 -1
2 1
Food
1 2 3 4 5 (units per week)
Chapter 3: Consumer Behavior Slide 37
Consumer Preferences
Marginal Rate of Substitution
Clothing 16 A
MRS C
(units
per week) 14 MRS = 6 F
12 -6
10 B
1
8 -4
D MRS = 2
6 1
-2 E
4 G
1 -1
2 1
Food
1 2 3 4 5 (units per week)
Chapter 3: Consumer Behavior Slide 39
Consumer Preferences
Marginal Rate of Substitution
Orange Juice
0 1 2 3 4 (glasses)
Perfect
3
Complements
0 1 2 3 4 Right Shoes
BADS
Things for which less is preferred to more
Examples
Air pollution
Asbestos
Styling Consumer
Preference A:
High MRS
Performance
Performance
Utility
Utility: Numerical score representing the
satisfaction that a consumer gets from a
given market basket.
Utility
If buying 3 copies of Microeconomics
makes you happier than buying one shirt,
then we say that the books give you more
utility than the shirt.
Utility Functions
Assume:
The utility function for food (F) and clothing (C)
U(F,C) = F + 2C
PFF PCC I
A 0 40 $80
B 20 30 $80
D 40 20 $80
E 60 10 $80
G 80 0 $80
Chapter 3: Consumer Behavior Slide 67
Budget Constraints
Clothing
Pc = $2 Pf = $1 I = $80
(units
per week)
A Budget Line F + 2C = $80
(I/PC) = 40
B 1
30 Slope C/F - - PF/PC
2
10
D
20
20
E
10
G Food
0 20 40 60 80 = (I/PF) (units per week)
60
A decrease in
income shifts
40 the budget line
inward
20 L3
(I = L1 L2
$40) (I = $80) (I = $160)
Food
0 40 80 120 160 (units per week)
C
MRS
F
Further, the slope of the budget line is:
PF
Slope
PC
Chapter 3: Consumer Behavior Slide 85
Consumer Choice
PF
MRS
PC
U1
+10F
40
D Market basket D
30 cannot be attained
given the current
budget constraint.
20
U3
Budget Line
A
20 At A:
MRS =Pf/Pc = .5
U2
Budget Line
0 20 40 80 Food (units per week)
Styling
$3,000
Styling
Since the indifference curves are steeper than the budget line,
the highest indifference curve will touch the budget line at the
lower right corner.
M = 200 / 4 = 50, P = 0.
Perfect
3
Complements
0 1 2 3 4 Right Shoes
A Corner Solution
At point B, the MRS of ice cream for frozen
yogurt is greater than the slope of the
budget line.
This suggests that if the consumer could
give up more frozen yogurt for ice cream
he would do so.
However, there is no more frozen yogurt to
give up!
A Corner Solution
When a corner solution arises, the
consumer’s MRS does not necessarily
equal the price ratio.
A Corner Solution
If the MRS is, in fact, significantly greater
than the price ratio, then a small decrease
in the price of frozen yogurt will not alter
the consumer’s market basket.
B
D
Clothing l1
(units per All market baskets
month) in the pink
shaded area are
l2 preferred to A.
B
D
B is preferred to
all market baskets
in the green area
l4
A
l2
B G
A: preferred to all I4: G revealed preferred to A
market baskets in
the green area
Food (units per month)
Other Scenario
Recreational •Roberta’s recreation budget = $100/wk
Activities •Price of exercise = $4/hr/week
($) •Exercises 10 hrs/wk at A given U1 & I1
100 C
80
•The rate changes to $1/hr + $30/wk
60 •New budget line I2 & combination B
A
B •Reveal preference of B to A
40 U1 U2
Would the Club’s
20 profits increase?
l1 l2
Amount of Exercise
0 25 50 75 (hours)
Example
The marginal utility derived from increasing
from 0 to 1 units of food might be 9
Increasing from 1 to 2 might be 7
Increasing from 2 to 3 might be 5
Observation: Marginal utility is
diminishing
Chapter 3: Consumer Behavior Slide 130
Marginal Utility and
Consumer Choice
Diminishing Marginal Utility
Formally:
0 MUF(F) MUC(C)
Rearranging:
C / F MU F / MUC
C / F MU F / MUC
Because:
MRS MUF/MUC
Chapter 3: Consumer Behavior Slide 135
Marginal Utility and
Consumer Choice
MUF/MUC PF/PC
Chapter 3: Consumer Behavior Slide 136
Marginal Utility and
Consumer Choice
MU F / PF MUC / PC