Consumer Behavior - Consumer Behavior Reynolds I....

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Reynolds-----EC303-------Consumer Behavior page 1 “Consumer Behavior” Reynolds I. Neoclassical economics assumes that individuals are “ rational .” A. Rational requires that individuals know their objective and all feasible alternatives. B. Individuals must establish criteria to evaluate each alternative with respect to the objective. C. Principle agent problem 1. When an agent acts on behalf of a principal, there may be imperfect information between the principal and agent. 2. The objectives of the agent may not be consistent with those of the principal 3. the principal-agent problem can be viewed as the process by which a contract can be designed to motivate the agent to act in the principal’s interests. II. Consumer choice is dependent on the set of possibilities and the preferences of the individual. A. The set of possible choices is defined by; 1. The income or budget of the individual 2. The prices of the set of goods (and services) available and relevant to the individual 3. The budget constraint can be defined as: M > P X Q X +P Y Q Y +. . . +P N Q N To simplify your life, consider two goods rather than N goods: M > P X Q X +P Y Q Y X X Y Y Where: M = income P = Price of good X Q = Quantity of good X P= P r i c eo fg o o dY Q =Quantity of good Y Problems: 1. If Q X = 16, How many units of good Y can be purchased? 2. If Q Y = 24, How many units of good X can be purchased? If income is $80 per month (M=80/m) while the price of good X is $4 (P X =4) and the price of good Y is $2.50 (P Y =2.50), the budget constraint can be graphed, If the entire $80 is spent on good X, 20 units can be purchased. This is shown as point A on the graph to the right, Q X = 20 If the $80 is spent on good Y, the maximum amount of good Y is 32, Q Y = 32. This is shown as point B. Any combination of goods X and Y (called a “bundle or market basket”) that falls on the line AB requires an expenditure of the entire $80. For example, a purchase of Q Y =16 and Q X = 10 requires an expenditure of $80. This is the budget constraint or budget line . All combinations on or inside the constraint are feasible . Any combination that lies in the triangle OAB (in yellow) is feasible and requires an expenditure less than $80. Any combination that lies outside the line AB will cost more than $80. This is the infeasible set. Q Y /ut Q X /ut 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 A B O
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Reynolds-----EC303-------Consumer Behavior page 2 4. Note that the quantity and income is regarded as a “ flow ,” i.e. it is measured as an amount during a specific period of time. 5. Summary: a) Bundles or market baskets that lie on the budget line or budget constraint AB are feasible and require an expenditure of exactly $M. b) Bundles that line inside the budget line cost less than $M and are also feasible. c) Bundles that lie outside the budget constraint require an expenditure of more than $M and are infeasible or unaffordable.
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Consumer Behavior - Consumer Behavior Reynolds I....

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