Consumer Behavior

The explanation of how consumers allocate income

to the purchase of different goods and services

Swati Pathak
IBS
 Consumer Behavior (2)
Consumer's equilibrium (UTILITY MAXIMIZATION)

Budget Constraint
Rational Choice
Affordability
Best Feasible Bundle

•Money Income Changes

•Prices of the goods change
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 The Budget Constraint
The consumer’s budget constraint
shows all of the combinations of goods
and services the consumer is able to
buy, given income and prices.

A fixed number of categories and all goods have a

positive marginal utility,

 opportunity set - all the bundles a consumer can buy,

including all the bundles inside the budget constraint and on
the budget constraint.
 The Budget Constraint
 We can represent the weekly budget for fruits (BUDF )
as: Affordability problem
(P Ox QO) + (PA x QA)  BUDF

PO and PA represent current price of oranges and

apples, respectively
QO and QA represent quantities of oranges and
apples you plan to consume during the week
An budget equation is derived when price of the
goods remain constant in two goods space

How Budget equation is derived????

 T- Hates T-
shirts

P- Hates
Movies

S,R,Q- Prefers
mix of each
goods

Where they consume depend on the strength of their preferences

q1 Budget Constraint is, M= p1q1+p2q2

5
Budget Equation is, Q2=(M/p2)- (p1/p2)q1

(0,(M/p1)) Slope= -p1/p2=dq2/dq1

4
A

B
Not Affordable
2
D

Affordable
1

C ((M/p2,)0)

1 2 3 4 6 7 q2
5
 Pivot of Budget Curve
If the price of ONLY one good changes, slope of the budget
constraint changes and budget line pivots

Pivot of Budget line around point A. What does it

QT mean?
Price of Tacos change!! Given price of hamburger
20 Case 1 : Doubling the price of tacos
to $1.00:
15 You can now afford either 5 tacos or 4
B burgers or a combination of both as
10 shown by new budget constraint, FA
-(PH/PT)
F case 2: 1.Lets cut the original price of
5 hamburger in half ! What would be the
budget line? ..THINK
A

0 2
QH
4 6 8
8
 Shifts of Budget
Money Income changes budget curve shifts parallel given
prices of goods remain constant.

As money income changes with the initial price level,

consumer can afford more on both the commodities and get
higher utility . Thus, budget curve shifts upward or
downward depending on income rises or falls.

If the price of both goods change by the

same proportion…What Will happen?
THINK
 Shift of Budget:
The Effect of Cutting Income by Half

Old income = M = $100, PF =10, PS =5

New Income = M’ = $50, PF =10, PS =5

M=$50 so that M/PF =50/10 =5 and M/PS =50/5= 10

Reducing income by half results in a parallel shift
inward of the budget constraint.
Note that changing income does NOT change the
slopes, i.e. slope of B2 = slope of B1 = -1/2
 The Budget Constraint
BUD reduced by 50%:
 Original budget line (BA) shifts in parallel
manner (same slope) to FG
QT  Same if both prices doubled
E
 Real income ↓
20
BUD doubled:
 BA shifts in parallel manner (same slope)
15
out to ED
 Same if both prices cut by 50%
B
10  Real income ↑

5
F

G A D
0 QH
G2 4 6 8
11
 Consumer Equilibrium
 Equilibrium is reached where consumer ‘s utility from that
combination of goods are maximized given the budget
constraint they face with the gives prices of the
commodities.

 At the equilibrium consumer has no intention to change

the consumption bundle along the indifference curve.

 The demand curve for a good can be derived from

indifference curves and budget lines by changing the
price of one of the goods (leaving everything else the
same) and finding the equilibrium points
 Consumer Equilibrium
indifference curve is tangent to the budget line, EQUILIBRIUM IS
ACHIEVED. Where slope are equal

MRS gasoline cds =(Price of gasoline/price of CDs)

= (P gasoline /P CDs )
 Two Conditions for Consumer Equilibrium

Equilibrium will be reached at the point of tangency between indifference

curve and budget constraint.
Necessary Condition

1. Tangency point shows, consumer obtain maximum satisfaction from

the combination of two goods given their budget constraint and prices
of two goods.
At Tangency point,

MRS gasoline cds =(Price of gasoline/price of CDs)

= (P gasoline /P CDs )

Sufficient Condition
2. At the equilibrium point, indifference curve must be convex to the
origin or MRS gasoline for cds will be diminishing.
 Income-Consumption Curve and Price
Consumption Curve
The Effects of Changes in Income
Income-consumption curve (ICC): plots combinations
of Good X and Good Y at different income levels given
prices of goods are constant
Budget line shifts

The Effects of Changes in price of one good

Price Consumption Curve (PCC): plots combinations of

Good X and Good Y at different price levels of any one
good given prices of other good and income constant
Budget line pivots around y-intercept /x-axis based on price of which good
has changed.
Pivots inward if rise in price of X
Pivots outward if fall in price of X

4-15
Income Consumption Curve
Price Consumption Curve (PCC)
When price of college education falls, given income
and other price constant
Constructing the Demand Curve (P falls)

Price Qd

250 C1

200 C2

150 C3