4_Consumer Theory

4_Consumer Theory - Chapter 4 Consumer Behavior and...

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Chapter 4. Consumer Behavior and Individual Demand 4.1.The Utility Function 4.1.1. Characteristics 4.1.2. Depicting the Utility Function: The Cobb-Douglas Illustration 4.2 Indifference Curves 4.3 Budget Constraints and Constrained Maximization 4.3.1. The Budget Constraint 4.3.2. Utility Maximization subject to the Budget Constraint 4.4 Comparative Statics 4.4.1. Money Income Changes 4.4.2. Proportional Absolute Price 4.4.3. Single Price Change Uncompensated Compensated: Separating the Income and Substitution Effects 4.5.The Individual’s Demand Curve 4.5.1. Compensated 4.5.2. Uncompensated 4.6.Consumer Surplus 4.7.Chapter Summary 4.8 Looking Ahead Economic models of consumer behavior assume that the consumer makes decisions that enhance his or her well being. 1 The consumer’s choices depend on preferences (referred to in terms of a “utility function” below) and constraints. This chapter explores a model of the consumer’s response to changes in money income and prices. It also shows how consumer surplus , introduced in the preceding chapter, is derived from the utility function. 4.1. The Utility Function Economic analysis of consumer behavior begins with a utility function . This function defines what determines the consumer’s level of well-being, however that term may be construed. The analyst typically does not specify a functional form for the utility function, except for 1 A wag has claimed that economics explores the implications of individuals’ decisions, and sociology explains why individuals cannot make decisions. Economics does not explore in depth how the consumer’s preferences are established. As principles textbooks point out, the reason for beginning at the individual level is to avoid committing the Fallacy of Composition. 4 -1
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purposes of illustration. (Of course, we must specify a functional form, and a fairly simple one, for our Excel -based illustration.) In general, the utility function may be written as follows: U = f(X 1 , X 2 , …, X N ; S 1 , S 2 , …, S M ). (4.1) In this equation, U is a measure of “utility” and X’s and S’s are goods or services (“goods” hereafter). We may specify two classes of goods, “material” goods, the X goods, (bread, butter, clothing, entertainment) and “spiritual” goods, the S goods, (love of one’s family, love of one’s God, love of one’s country). Economics focuses primarily, though not exclusively, on the X goods. 4.1.1 Characteristics of a Utility Function In general, an acceptable utility function must satisfy three conditions: it must be complete (that is, a utility level must be attached to every combination of goods and services that the consumer can enjoy), it must depict consistent behavior, and it must satisfy a transitivity condition. In addition, we commonly add an assumption that for all goods more is preferred to less. 1.
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4_Consumer Theory - Chapter 4 Consumer Behavior and...

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