ln%203 - Lecture note It: Theory of consumer behavior...

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 4
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 6
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 8
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 10
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Lecture note It: Theory of consumer behavior Somasrce Dasgupta Fem 5|]! .i'tl AutmanUfl? Theory of consum or behavior: Description ofbow consumers allocate their iimiteci income among iii tierent goods anti services to maximize their welt-being. The theory of consumer behavior is characterized by three distinct steps- I Consumer Preferences I I Budget Constraints I Consumer Choices lll‘onsmner Preterenees: What are the masons for people preferring one guest to the other? Market hash-:1 {or bundle}: List with specific quflflliiifls of one or more goods. Rational consumers want to select market baskets that make them as well off i or satisfied} as possible. Some basic assumptions about preferences: I. Cont pletenras: Consumers can compare and rank all possible market baskets. Thus for antr two market baskets a and H, a consumer will either prefera to E, or will pretbr B to it or will be indiii'crent between the two. l-iowcs'er, those preferences ignore costs, 1which will influence the actual choice. 2. T ransitiirity: if a consumer prefers basket A to basket B and basket [i to basket C, then 'he consumer also prefers A to (7. this assumption is necessary for the consumer to be consistent. 3. More is better than tessit Non satiation: Goods are always desirable I_'“good"}. Consumers always prefer more of any good to less. So we ignore “beds” like air pollution in this analysis. these assumptions impose a degree at ratiornaiit}.P among consumers. l Indifference Curves (1C): Graphieat representation of eonstuner's preferences. An indifference curve represents all combinations of market baskets that provide a consumer 1with Lite same level of satjstaetion. How do we graph a eonsnmer‘s indifference cunts? Let us assume that there are only two gwdrj eti'ailabic for consumption, food and clothing. Then, all market baskets describe combinations of food and clothing that a person might wish to consume. ,riss" we soon) «A. w§(l f-Q .B a r " H ': .{g hp sect (mil; he were) Because of the assumption of more is preferred to fees we can compare market baskets in the shaded areas. Basket A is preferred to basket [3, while basket E is preferred to A- However, A cannot heeornpared with B, D, or [1 without additional information. Suppose that the additional inforrrtaliort is that the consumer is indifferent boost-eon the three market baskets :1, s. D. So we e-artdraw an indifference curve through these three mints. Moving from one point on the indifference curt-re to another, the consumer is neither hotter off not worse off. T CR“??? ( We) { -.... ._ I. if} ' '1 Cr — —' ' J— — a Eli—tclt (El-rth? f'fi'h‘ ‘f'wflkffi D Fr J.- lndil'l'erenee map: Graph containing a set of indifference curves. Hang? Fol hit—IE) D )fi'eirl-(w pouring) Some imminent properties [llllfltllffifl'fll'mfl curves: - on indifference curve is always downward sioping.{ given assumption of non satiatiom’more is better}. I in or. ilieil'ferenee map, a higher 1C alwayseorresponds lo :1 hi gher level of satisfaction for the consumer. ' Two indifference curves eon never intersect. I indifference eurves are usually convex The life represent trade offs that people face. The shape ofan indifference eunre demibes hour a consumer is willing to substitute one good for another. The more elotliing and The less Food :1 person ermsumes, the more clothing he 1will give up in order to obtain more Food. Similarly, the more food that a person possesses, the less clothing he will give up for more food. Marginal Rate ol' Substitution {MRS}: Maximum amount of a good that a eonsamer is willing to givetllig in order to obtain one additional unit of another guest. “6 Kfihfij (“NJ-3 P“ amij I “1 .IHI i: 1“I i .. 1.3.3 5 |'-|I ll I} G ‘— —‘1:_ I ' ~E" E I T's-IEH l 1 . 1‘ 1.— —.—r— .- _ "E? Ffiua (unit; Fol Home} r 2. 1- * "'| s In the diagram above MRS = - {fiClothingM Food}. We have the negative sign in front to make MRS a positive number The MRS at an};r point on the IC is equal in magnitude to the slope of flte indifference curve. For example, in the figure above, MRS between the pointsA endE is e. Diminishing Marginal rate of Substitution: We assume that consumer preferences exhibit diminishing MRS, that is the MRS falls as we move down the IC .This is consistent with the convexity of indifference curves. The intuition is: that as more and more of one good is consumed we can expect the consumer 1will prefer to give up fewer and fewer units of the second good to get additional units of the first one. Perfect Substitutes: 'I'wo goods for which the MRS ofone for the other is a constant. Such goods are represented by linear le. flash njw‘in gases-a) {Iii—0.? J'uo‘t a wen} Perfect Complements: Indifihrenee Curves are shaped at right angles for perfect complements. Ls-f }- shoes it is pomible to describe eonsumer preferenees by assigning soores to the levels of satisfaction associated with eaeh indifference eune. litility: Numerical seere representhtg the satisfaetioo that a eonsumer gets fi‘em a given market basket. Utility funetion: Fonnula that assigns a level of utility to individual market baskets. If maritet basitet a is preferred to B, then utilit}r frontA will be higher titan utility from B. Example: lJ[F,C)= Ff. Ruppnse there are three market baskets, A=[ 2F,6C}.B= (3533(3), C= {5F,2C).It is obvious that utility from A is same as utility.r flout B and the is greater titan utility from (J. this means that the consumer is ind ifiereot between A and B and prefers each ofA and E to C, Cardin 31 Utility function: Utility fimetion describing by hie-ur mueh one market basltet is preferied to another. Drdinal utility,r function: Utilit},r funetion that generates a ranking of market baskets in order of most tn least preferred. However, it does not indicate by how much one is preferred to another. Read page T! from the book. Budget Constraints: Constraints that consumers face as a result of limited ineornes. Suppose a eonsurrter has a fixed ineome I that ean be spent on focal and clothing. Let P; and Pgbe Ihe prises per unit of Food and clothing respectively. Then the budget line would indicate all eomhinations offend and clothing for which the total amount of atone],r spent is equal to income. In this ease, the budget line 1ail] be given by: HP + Pei? = l Problem: Draw the budget line fora consumer when Pr = 3 l per until, Pr- — $ 2 per unit and i e 3 fill. The equation ofthe budget line is given by: r + at: = an 112—- (sure) ans; r This is a downward sloping, shaight line with vertical intercept of4l} and slope -1r’2. Generally, a budget line is always downward sloping with a vertical intercept of L'Pcand a slope of ~ '{P‘or Fe}. The magnimde ol‘ the slope toils us the rate at which the two goods eon be substituteo For each other without changing the total amount of mono}.r spent. What happens to the budget line when - Income changes {with prices unchanged) Suppose income of consumer From $30 to $Iflfl. mm? (we to mo 1,5. \ \ \x \ x . I. \ VF.— _' :I'ifit! If 1-. ob \ "a \“ X _ _T_ '=' r" I o {Earl (with PM MUN) - Price ehangeet: with ineeme mtehenged) Suppose prtee per unit of feed rieee Trent It be $2. Clnflufil (Lulu-in; '14-‘91 male) rm fl».an (unit; trek Luna} Consult-er Clluiee: A ettnttumer eheesee eemhinatien et‘ gee-tie te maximize the satisfaetien he ear: eehieve given the Itmil‘eti budget available to him. The eenstuner'e ehuiee must eatist'y 1WD eenditiens: 1' It must he leeated en the budget lie-e. - It must give the commence the meet pretened enmhinatien ef geeds and servieee. chafing.» {meet-i PM: mate} —-—§, Em! (welt; feta butt-tit) a: ._ Let us assume that the consumer eeneumes pesitive quantities ef heth geeds .ln the above diugrmn, the consumer maximizcs satisfactiutl by eiluuuing the market basket A. It is a mint eftaneeneu between an it: and the budget line. A is called the nptima] eheiee m' the eensumer. At A. the slepe efthe budget line is: exactly equaitn the elepe ef the indi rt‘erenee eurve. E5 (fltCi'th ]I '— (-PP'T'e} =5 MRS= t-fiCflF} = {Pith} w MRS {oi F for C): ratio of prieeatof F to C} E? Marginal benefit = Marginal cost L'orner‘ Solutions: A consumer ma],r choose to purchaoe only one good out. of the two. When one ofthe goods is not eonsurnedr the optimal eonatunption bundle appears at the comer ofthe graph. This is known as a corner solution. Witter: acomer sotmjen arises, the consumer‘s MRS does not neeenotaril},r equal the price rant“ iii-o 14:1. Ht‘fikflij (NJ-{W f" *1me) fl é:— EL’J?’ L1! “'7 u} \ aunt, I“ "f .- \ l... l Fen. Chew-rt (mp3 Fad. Him-L113) Marginal Utility {MU}: Additional satisfaction obtained from consuming one additional unit of a good. Diminishing marginal utility: Principle that an rcore of a good is consumed. the consumption of addilitmal amounts will yield smaller additions to utility. Consider a small movement down an indifi'erence curve. The additional concumntion of Food hF will generate marginal utility of MUp. "[1113 mule; in a total increase in utility.F of MUF of. At the some lime. the reduced consumption of clotting , at, Will result in a inlet! utility 1055 (if MU; at. Because all points on an indifference curve generate the same lech ot‘utility, E Term} gain in tttili’t}.F + total loss in utility = t] MUF. r517 + MU; £1: = [I 4 AW AF) = MUFr MUP MKS = MUP" MUe A1505 from earlier, MRS -F PEER; Therefore, = MU?! Mug: FIJI-fl; Alternatively. MUH‘TI = MUri'Pr‘ This implies that utilit},r maximietttjen is aehieved when the budget is ellttealet] :iu that the marginal utiiity per dollar e-i expenditure isthe NHTI'IE I'nr melt gated. This is called the equal} marginal prineiple. Reed examplesll 3.4. 3.6 and 3.? Read seetien 3.4 on revealed preference. 1) HS page 3?,exe1'eise l 2] HS page 33,:exeruiac 2 3] HS page 4fl,exereise 3 4) HS page 4fl,exerciae 4 5) HS page 42,exerei5a 15 5) HR page. :34, EKETEiRE {P 7) HS page 46,exereiae 10 El) HS page =18, probiam ll . 9'} HS page 43.]:rroblcm 15 HT] PR page 103,queatipna fur review: questions 2, 4,5 l 1] PR page IDLqucstian 1' ID ...
View Full Document

This note was uploaded on 04/28/2008 for the course ECON econ taught by Professor Daspugata? during the Winter '08 term at Ohio State.

Page1 / 10

ln%203 - Lecture note It: Theory of consumer behavior...

This preview shows document pages 1 - 10. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online