Professional Documents
Culture Documents
V02 Section 6 - The Theory of Consumer Choice 220427
V02 Section 6 - The Theory of Consumer Choice 220427
THE THEORY OF
CONSUMER CHOICE
The budget constraint:
what the consumer can afford
Marginal utility theory & Preferences
1
The budget constraint:
what the consumer can afford
Budget constraint:
• The limit on the consumption bundles that a
consumer can afford
• The Budget Line
• Nam has $4 a day to spend on two goods: bottled
water (X) and gum (Y).
• The price of water is $1 a bottle.
• The price of gum is 50¢ a pack.
2
The budget constraint
The line passing through the
Chewing gum (packs per day) points is Nam’s budget line.
Water Chewing
gum
Possibility (bottles
per day) (packs per
day)
A 0 8
Unaffordable
B 1 6
C 2 4
D 3 2
E 4 0
Affordable
Budget line
3
Water (bottles per day)
The budget constraint:
what the consumer can afford
The consumer’s budget constraint shows the various
bundles of goods that the consumer can afford.
The slope of the budget measures the rate at which
consumer can trade one good for another. It is the
relative prices of the two goods.
Y
8 •A
4 •C
Budget Line
O •E
2 4
X
4
The budget constraint
A Change in the Budget
• When a consumer’s budget increases,
consumption possibilities expand.
• When a consumer’s budget decreases,
consumption possibilities shrink.
5
The budget constraint
Chewing gum (packs per day)
An increase in the
Budget $6
budget shifts the budget
line rightward.
Again, the slope of the
Budget $4 budget line doesn’t
change because prices
have not changed.
Budget $2 BL2
BL1
BL3
6
Water (bottle per day)
The budget constraint
Changes in Prices
• If the price of one good rises when the prices
of other goods and the budget remain the
same, consumption possibilities shrink.
• If the price of one good falls when the prices
of other goods and the budget remain the
same, consumption possibilities expand.
7
The budget constraint
When the price of water falls, the budget line rotates outward and becomes less steep.
Chewing gum (packs per day)
Water
(bottles per day)
Chewing
Possibilit $1 5€ a gum
y a bottle bottle (packs
per day)
A 0 0 8
Water 5€ B 1 2 6
C 2 4 4
Water $1
D 3 6 2
E 4 8 0
Water (bottles per day)
8
The budget constraint
Chewing gum (packs per day)
When the price of water
rises, the budget line rotates Water
(bottles per day)
inward and becomes steeper Chewing
$2 $1 gum
Possibility a bottle a bottle (packs per
day)
A 0 0 8
Water $1 1 6
B 1 2 4
Water $2 BL1
BL4 3 2
C 2 4 0
∆ 𝑻𝑼𝒙 𝑑𝑇𝑈
𝑴𝑼 𝒙= =
∆ 𝑸𝒙 𝑑𝑄
10
Marginal Utility Theory
Q TU MU
𝑀𝑈 𝑛 =𝑇𝑈 𝑛 − 𝑇𝑈 𝑛−1 0 0 -
1 15 15
2 27 12
3 36 9
4 42 6
5 47 5
6 51 4
7 54 3
8 56 2
9 56 0
TUX = 2X + 4X
2
10 53 -3 11
MUX = 4X + 4
Marginal Utility Theory
We call the general tendency for marginal utility to
decrease as the quantity of a good consumed
increases the principle of diminishing marginal
utility.
12
Marginal Utility Theory
13
Marginal Utility Theory
Marginal Utility
The downward
sloping blue line
is marginal
utility curve.
Quantity of X
15
Preferences: what the consumer wants
1. Higher indifference curves are preferred to lower ones
Quantity of Y
IC3
IC2
IC1
O
Quantity of X
16
Preferences: what the consumer wants
Y
•B
X
U (IC)
Quantity of X 17
Preferences: what the consumer wants
3. Indifference curves cannot cross
Quantity of Y
A
B
IC1
C
IC2
O
Quantity of X
18
Preferences: what the consumer wants
4. Indifference curves are bowed inward
Marginal rate of substitution (MRS): the rate at which
a consumer is willing to trade one good for another
Quantity of Y
•A (1,6)
Y
X •B (2, 3)
Y
X •C (3,2)
Y
•D (6,1)
X IC
Quantity of X
19
Optimization: what the consumer chooses
Nam has VND55k a day to spend on two goods: X and Y
• The price of X is 10k VND a unit.
• The price of Y is 5k VND a unit.
X,Y 1 2 3 4 5 6 7
20
Optimization: what the consumer chooses
21
Optimization: what the consumer chooses
X TUx MUx MUx/Px Y TUy MUy MUy/Py
0 0 0 0
1 60 60 6 1 20 20 4
2 110 50 5 2 38 18 3,6
3 150 40 4 3 53 15 3
4 180 30 3 4 64 11 2,2
5 200 20 2 5 70 6 1,2
6 206 6 0,6 6 75 5 1
22
Optimization: what the consumer chooses
23
Optimization: what the consumer chooses
Assumption: the consumer maximizes his/her satisfaction, subject
to his/her budget constraint
The consumer’s optimal choice:
• The consumer optimizes by choosing the point on her budget
constraint that lies on the highest indifference curve
Quantity of Y
•D
•A Optimal choice
IC3
•E
IC2
•C IC1
O BL
Quantity of X 24