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Econ 4010 Lecture 2

# Econ 4010 Lecture 2 - 3 Consumer Behavior...

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<Lecture 2> 3. Consumer Behavior: Maximizing Utility Two components in consumer behaviour: Preferences (indifference curve) & Constraints (budget line) Indifference curves represent the "willingness" aspect of consumer demand, while the budget line captures the "ability". Budget Line A budget line illustrates all the possible combinations of goods that can be purchased at given prices and for a given consumer budget. The amount of a good that a consumer can afford will depend on the consumer's income and the price of the goods. Consumer's Income: I = \$80 Price of Food: P F = \$1 Price of Clothing: P C = \$2 Budget line: P F F + P C C = I => F + 2C = 80 It can be re-written: C = -[P F /P C ]F + I/P C => C = -(1/2)F + 40: Slope is -1/2 The slope of the budget line is the negative of the relative price of two goods. (the ratio of the prices) Let's think about how the change in the determinants will affect the budget line. A change in consumer income causes the budget line to shift parallel to the original line. i) An increase in consumer income (\$80 => \$160) If consumer income increases then the consumer will be able to purchase higher combinations of goods. Hence an increase in consumer income will result in an outward shift in the budget line. F + 2C = 80 => F + 2C = 160 ii) A decrease in consumer income (\$80 => \$40) If consumer income fell then the potential combinations of the two goods that can be purchased also fell. There would be a corresponding parallel shift to the left to represent a decrease in the potential combinations of the two goods that can be purchased. F + 2C = 80 => F + 2C = 40 1

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If income is held constant, and the price of one of the goods changes then the slope of the curve will change. In other words, the curve will pivot. i) A decrease of price of food (\$1 => \$1/2) The reduction of the price of food from \$1 to 50 cents means that on a fixed budget of \$80, the consumer could purchase a maximum of 160 units, as opposed to 80. Note that the price of clothing has remained fixed, hence the maximum point for clothing will remain fixed. Because the price of food falls with respect to clothing, if one gives up a unit of clothing, one can now get more of food than before. Therefore the slope is now flatter. F + 2C = 80 => (1/2)F + 2C = 80 ii) An increase in price of food (\$1 => \$2) The budget line would be steeper than the original budget line, reflecting the rise of the price of food from \$1 to \$2.
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