chapter 5:
DESCRIPTION
Chapter 5:. Consumer Choices and Economic Behavior. Key Topics. The budget constraint Definition, equation, graph, opportunity cost Impact of Δ I, Δ P x , Δ P y Utility Total and marginal Indifference curve: definition, slope Utility maximization. Key Topics. - PowerPoint PPT PresentationTRANSCRIPT
Key Topics
1. The budget constrainta. Definition, equation, graph, opportunity cost
b. Impact of ΔI, ΔPx, ΔPy
2. Utilitya. Total and marginal
b. Indifference curve: definition, slope
c. Utility maximization
Key Topics
3. Downward-sloping demand factorsa. Diminishing marginal utility
b. Income effect
c. Substitution effect
4. Other consumer decisionsa. Work or leisure
b. Save or borrow
Questions
1. What does it mean if you have a ‘budget constraint’?
2. How can your attainable consumption choices be shown mathematically and graphically?
Budget Constraint
The maximum Q combinations of goods
that can be purchased given one’s income and the prices of the goods.
Budget Constraint Variables
I (or M) = the amount of income or money that a consumer has to spend on
specified goods and services.
X = the quantity of one specific good or one specific bundle of goods
Y = the quantity of a second specific good or second specific bundle of goods
Px = the price or per unit cost of X
PY = the price or per unit cost of Y
Budget Line: Axis Intercepts & Slope
Vertical Axis Intercept
= I/PY
= max Y (X = 0) Horizontal Axis Intercept
= I/PX
= max X (Y = 0) - Slope
= PX/PY
= ‘inverse’ P ratio
= X axis good P/Y axis good P
= Y/X
Changes in the Budget Line
Changes in Income
- Increases lead to a parallel,
outward shift in the budget line.
- Decreases lead to a parallel,
downward shift. Y
X
Changes in the Budget Line
Changes in Price
- A decrease in the price of good X rotates the budget line counter-clockwise.
- An increase rotates the budget line clockwise.
I Px
/1
New budget line fora price decrease
X
Y
I Px/ 2
Q. What Are Your Preferences?
LunchA: 1 drink, 1 pizza sliceB: 1 drink, 2 pizza slicesC: 2 drinks, 1 pizza slice
EntertainmentA: 1 movie, 1 dinnerB: 1 movie, 2 dinnersC: 2 movies, 1 dinnerFor each, indicate which of the following you prefer:
A vs B, B vs C, or A vs C
Utility Concepts
Utility:satisfaction received from consuming goods
Cardinal utility:satisfaction levels that can be measured or specified with numbers (units = ‘utils’)
Ordinal utility:satisfaction levels that can be ordered or ranked
Marginal utility:the additional utility received per unit of additional unit of an item consumed (ΔU/ ΔX)
Utility Assumptions
1. Complete (or continuous) can rank all bundles of goods
2. Consistent (or transitive) preference orderings are logical and consistent
3. Consumptive (nonsatiation) more of a ‘normal’ good is preferred to less
More of a Good is Preferred to Less
The shaded area represents those combinations of X and Y that are unambiguously preferred to the combination X*, Y*. Ceteris paribus, individuals prefer more of any good rather than less. Combinations identified by “?” involve ambiguous changes in welfare since they contain more of one good and less of the other.
Indifference Curve
Indifference Curve A curve that defines the
combinations of 2 or more goods that give a consumer the same level of satisfaction.
Curves further from origin represent higher utility levels
A ‘bad’ good, or an economic ‘bad’ is an item that a consumer does not like or enjoy, which means their total satisfaction level is lower the more of the item they have. This also means the marginal utility of the item is negative.
MRS & MU
MRS= - slope of indifference curve= -Y/ X= the rate at which a consumer is willing to
exchange Y for 1more (or less) unit of XU = 0 along given indiff curve
= MUx(X)+MUY(Y) = 0
= - Y/ X = MUx/MUY
= - slope = inverse MU ratio
Consumer Equilibrium (U Max)
The equilibrium
consumption
bundle is the
affordable bundle
that yields the
highest level of satisfaction.
Individual Demand Curve
An individual’s demand curve is derived from each new equilibrium point found on the indifference curve as the price of good X is varied.
Diminishing Marginal Utility
The law of diminishing marginal utility:
The more of one good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good.
Diminishing Marginal Utility and Downward-Sloping Demand
Diminishing marginal utility helps to explain why demand slopes down.
Marginal utility falls with each additional unit consumed, so people are not willing to pay as much.
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25
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Thai meals per month
Pric
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Income and Substitution Effects of a Price Change (for normal goods)
Household isbetter off
(higher real income)
Opportunitycost of thegood falls
Household isworse off
(lower real income)
Opportunitycost of thegood rises.
Incomeeffect
Substitutioneffect
Incomeeffect
Substitutioneffect
Householdbuys more
FALLS
RISES
Householdbuys more
Householdbuys less
Householdbuys less
Price of agood or service
Household Choices in Labor Markets
As in output markets, households face constrained choices in input markets. They must decide:
1. Whether to work2. How much to work3. What kind of a job to work atThese decisions are affected by:1. The availability of jobs2. Market wage rates3. The skill possessed by the household
The Price of Leisure
W = wage rate
= the price (or the opportunity cost or lost benefits) of either
unpaid work or leisure.
The Labor Supply Curve
The labor supply curve is a diagram that shows the quantity of labor supplied at different wage rates.
Saving and Borrowing: Present Versus Future Consumption
Households can use present income to finance future spending (i.e., save), or they can use future funds to finance present spending (i.e., borrow).
In deciding how much to save and how much to spend today, interest rates define the opportunity cost of present consumption in terms of foregone future consumption.