DEMAND AND CONSUMER BEHAVIOR

1
DEMAND AND CONSUMER BEHAVIOR

• CHAPTER 5

2
Choice and Utility Theory

• Utility measures the want-satisfying power of a
  good or service.
• Marginal utility is the rate at which utility
  changes as each additional unit of a particular
  good is consumed

3
Total and Marginal Utility Schedules
Number of films attended per month
Total utility
Marginal utility
0
0.00
1
15.00
15.00
2
25.00
10.00
3
31.00
6.00
4
35.00
4.00
5
37.50
2.50
6
39.00
1.5
7
1.25
40.25
8
41.30
1.05
9
0.90
42.20
10
0.80
43.00
4
Chapter 5 Table 5-1
5
Total and Marginal Utility Curves
50
20
40
15
30
Utility
10
Utility
20
5
10
4
6
8
10
0
4
6
8
10
0
2
2
Quantity of films attendance per month
i. Increasing total utility
ii. Diminishing marginal utility
6
The law of diminishing marginal utility

• As the amount of a good consumed increases, the
  marginal utility of that good tends to diminish.
• That is, the more you have of any one thing, the
  less an additional unit of it is worth to you.

7
The Law of Diminishing Marginal Utility
Chapter 5 Figure 5-1
8
Income Constrains Consumer Spending
Appendix 5A Figure 5A-3
9
Utility cannot be measured

• Utility is an important concept for economists,
  but there is no cardinal measure of it. That is,
  there is no scale or instrument upon which
  utility can be measured.
• Instead, we rely on ordinal measures, which
  simply rank items relative to one another

10
Bundles Conferring Equal Satisfaction
Clothing
Food
Bundle
a
30
5
b
18
10
c
13
15
d
10
20
e
25
8
f
7
30
An Indifference Curve
35
a
30
25
g
Quantity of clothing per week
20
b
15
c
d
10
e
f
h
T
5
I
5
10
15
20
25
30
35
Quantity of food
11
Indifference Curves for a Pair of Goods
Appendix 5A Figure 5A-1
12
Bundles Conferring Equal Satisfaction

• None of the bundles in the table are obviously
  superior to any of the others in the sense of
  having more of both commodities.
• Since each of the bundles shown in the table give
  the consumer equal satisfaction, he is
  indifferent between them.
• The data in this table are plotted in the
  corresponding figure.

13
An Indifference Map
Quantity of food per week
I5
I4
I3
I2
I1
0
Quantity of food per week
14
An Indifference Map

• A set of indifference curves is called an
  indifference map.
• The further the curve from the origin, the higher
  the level of satisfaction it represents.
• Moving along the arrow, is moving to ever-higher
  utility levels.

15
Shapes of Indifference Curves
Perfect Substitutes
Perfect Complements
A good that gives zero utility
Vegetables
Left hand gloves
Packs of red pins
I1
I1
I1
0
0
0
iii. Meat
i. Packs of green pins
ii. Right hand gloves
A good that confers a negative utility after some
level of consumption
A good that is not consumed
An absolute necessity
I1
a
All other goods
All other goods
All other goods
I2
I1
0
f0
I1
w
b
0
0
v. Food
iv. Water
vi. Good X
16
Shapes of Indifference Curves
Perfect Substitutes
Perfect Complements
A good that gives zero utility
I2
Vegetables
Left hand gloves
Packs of red pins
I2
I1
I2
I1
I1
0
0
0
iii. Meat
i. Packs of green pins
ii. Right hand gloves
A good that confers a negative utility after some
level of consumption
A good that is not consumed
An absolute necessity
I2
I1
a
All other goods
All other goods
All other goods
I2
I2
I1
0
f0
I1
w
b
0
0
v. Food
iv. Water
vi. Good X
17
The Equilibrium of a Consumer
35
30
25
Quantity of clothing per week
20
15
10
5
5
10
15
20
25
30
35
Quantity of food per week
18
The Equilibrium of a Consumer
35
30
a
25
Quantity of clothing per week
20
15
10
5
f
I1
5
10
15
20
25
30
35
Quantity of food per week
19
The Equilibrium of a Consumer
35
30
a
b
25
Quantity of clothing per week
20
15
10
5
e
I2
f
I1
5
10
15
20
25
30
35
Quantity of food per week
20
The Equilibrium of a Consumer
35
30
a
b
25
c
Quantity of clothing per week
20
15
10
d
5
e
I3
I2
f
I1
5
10
15
20
25
30
35
Quantity of food per week
21
The Equilibrium of a Consumer
35
30
a
b
25
c
Quantity of clothing per week
20
E
15
10
d
I4
5
e
I3
I2
f
I1
5
10
15
20
25
30
35
Quantity of food per week
22
The Equilibrium of a Consumer
35
30
a
b
25
c
Quantity of clothing per week
20
E
15
10
I5
d
I4
5
e
I3
I2
f
I1
5
10
15
20
25
30
35
Quantity of food per week
23
Consumers Most Preferred and Feasible
Consumption Bundle Is Attained at B
Appendix 5A Figure 5A-4
24
Consumer Equilibrium Condition

• Utility is maximized subject to a budget
  constraint if the ratios of marginal utility to
  price for all goods are equal
• ? the marginal utility of the last dollar spent
  is the same regardless of where it is spent.
• ?MUX /PX MUY / PY
• And PXQX PYQYm

25
Example PX2 PY1 m12
26
An Income-consumption Line
Income-consumption line
Quantity of clothing per week
0
Quantity of food per week
27
An Income-consumption Line
Income-consumption line
Quantity of clothing per week
E1
I1
0
Quantity of food per week
28
An Income-consumption Line
Income-consumption line
Quantity of clothing per week
E2
E1
I2
I1
0
Quantity of food per week
29
An Income-consumption Line
Income-consumption line
Quantity of clothing per week
E3
E2
E1
I3
I2
I1
0
Quantity of food per week
30
Effect of Income Change on Equilibrium
Appendix 5A Figure 5A-5
31
The Price-consumption Line
Quantity of clothing per week
I1
Quantity of food per week
32
The Price-consumption Line
a
E1
Quantity of clothing per week
I1
b
Quantity of food per week
33
The Price-consumption Line
a
E1
Quantity of clothing per week
E2
I2
I1
b
c
Quantity of food per week
34
The Price-consumption Line
a
E1
Quantity of clothing per week
E2
E3
I3
I2
I1
d
b
c
Quantity of food per week
35
The Price-consumption Line
a
Price-consumption line
E1
Quantity of clothing per week
E2
E3
I3
I2
I1
c
d
b
Quantity of food per week
36
Effect of Price Change on Equilibrium
Appendix 5A Figure 5A-6
37
why demand curves are downward-sloping

• Utility theory helps to explain why demand curves
  are generally downward-sloping, as was argued in
  Chapters 3 and 4.
• As the price of good X falls, the quantity of X
  consumed rises, and so MUX falls with price.

38
Derivation of an Individuals Demand Curve
Value of all other goods per month
E0
I0
220
120
60
267
400
0
800
i Petrol liters per month
x
0.75
Price of petrol per month
0.50
0.25
60
120
220
0
ii Petrol liters per month
39
Derivation of an Individuals Demand Curve
E1
Value of all other goods per month
E0
I1
I0
220
120
60
267
400
0
800
i Petrol liters per month
x
0.75
y
Price of petrol per month
0.50
0.25
60
120
220
0
ii Petrol liters per month
40
Derivation of an Individuals Demand Curve
E2
E1
Value of all other goods per month
E0
I2
I1
I0
220
120
60
267
400
0
800
i Petrol liters per month
x
0.75
y
Price of petrol per month
0.50
z
0.25
60
120
220
0
ii Petrol liters per month
41
Derivation of an Individuals Demand Curve
Price-consumption line
E2
E1
Value of all other goods per month
E0
I2
I1
I0
220
120
60
267
400
0
800
i Petrol liters per month
x
0.75
y
Price of petrol per month
0.50
Demand curve
z
0.25
60
120
220
0
ii Petrol liters per month
42
Substitution Vs. income effects

• Substitution and income effects also help to
  explain the negative correlation between price
  and quantity demanded.
• Substitution effects describe the fact that as
  prices change along a demand curve, consumers
  substitute relatively cheaper goods into their
  market baskets.
• Income effects describe the fact that as prices
  change along a demand curve, money income is held
  fixed, but real income or purchasing power
  changes.
• This means that consumers are not able to buy as
  much at higher prices.

43
The Income and Substitution Effects
Value of all other goods per week
I1
0
Quantity of petrol liters per week
44
The Income and Substitution Effects
a
Value of all other goods per week
I1
0
b
Quantity of petrol liters per week
45
The Income and Substitution Effects
a
E0
Value of all other goods per week
I1
0
b
q0
Quantity of petrol liters per week
46
The Income and Substitution Effects
a
a1
E0
Value of all other goods per week
I1
0
j1
b
q2
q1
q0
Quantity of petrol liters per week
47
The Income and Substitution Effects The
Substitution effects is defined by sliding the
budget line around a fixed indifference curve The
income effect is defined by a parallel shift of
the budget line. To higher or lower indifference
curve
a
a1
E0
Value of all other goods per week
E1
Substi tution effect
I1
0
j1
b
q2
q1
q0
Quantity of petrol liters per week
48
From Individual to Market Demand

• Market demand curves reflect, for any price, the
  total quantity demanded across many individuals.
  They are the horizontal sum of individual
  demand curves.

49
Market Demand Derived from Individual Demands
Chapter 5 Figure 5-2
50
Demand Curve Shifts with Changes in Income or in
Other Goods Prices

• the demand for a good shifts when any factor
  other than the price of the good itself changes.
• When money income changes, demand curves shift
  the magnitude of this shift depends upon income
  elasticity, which measures the percentage change
  in quantity demanded resulting from some
  percentage change in income.
• When prices of other goods change, demand curves
  shift the magnitude of this shift depends upon
  cross price elasticities, which measure the
  percentage change in quantity demanded resulting
  from some percentage change in the price of
  another good.

51
Demand Curve Shifts with Changes in Income or in
Other Goods Prices
Chapter 5 Figure 5-3
52
Normal Vs. Inferior Goods

• Goods can be either normal or inferior.
• With a normal good, as income increases, demand
  increases (or shifts to the right).
• With an inferior good, as income increases,
  demand decreases (or shifts to the left).
• For example, for many people cars and stereos are
  normal goods.
• For many people, used clothes and Spam are
  inferior goods.
• Remember, though, that definitions of normal and
  inferior goods are subjective and based upon
  individual preferences.

53
Engels curve
54
Chapter 5 Table 5-3
55
Complements VS. Substitutes

• Goods can be related in two different ways.
• Complements are goods that are consumed together.
• Substitutes are goods that are consumed in place
  of one another.
• Goods are independent when the consumption of
  one does not depend on or affect consumption of
  the other.

56
Consumer Surplus

• Consumer surplus represents the difference
  between what people would have been willing to
  pay, and how much they actually had to pay in a
  market.
• Remember that a demand curve represents the
  maximum amount that consumers would be willing
  and able to pay for each unit of a good.
• This means that consumers typically receive a
  surplus that is, some consumers receive value
  from a good or service in excess of the amount
  that they paid for it.

57
Consumers Surplus for an Individual
3.00
2.00
Price of milk per glass
Market price
1.00
0.30
1
2
3
4
6
8
9
7
5
10
Glasses of milk consumed per week
58
Consumers Surplus for the Market
Price
D
Quantity
0
59
Consumers Surplus for the Market
Price
Market price
p0
D
Quantity
q0
0
60
Because of Diminishing Marginal Utility,
Consumers Satisfaction Exceeds What Is Paid
Chapter 5 Figure 5-6
61
Total Consumer Surplus Is the Area under the
Demand Curve and above the Price Line
Chapter 5 Figure 5-7