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03.
Consumer Behaviour
1
The Consumer’s Optimization Problem
2
Consumer Optimization
(Marginal Utility Interpretation)
I = $ 11, PX = $ 1, PY = $ 2
4
Typical Consumption Bundles for Two
Goods, X & Y
5
Properties of Consumer Preferences
• Completeness
• For every pair of consumption bundles, A and B, the
consumer can say one of the following:
• A is preferred to B
• B is preferred to A
• The consumer is indifferent between A and B
• Transitivity
• If A is preferred to B, and B is preferred to C, then A
must be preferred to C
• Nonsatiation
• More of a good is always preferred to less 6
Utility
7
Indifference Curves
8
Typical Indifference Curve
9
Marginal Rate of Substitution
• MRS shows the rate at which one good can be
substituted for another while keeping utility
constant
• Negative of the slope of the indifference curve
• Diminishes along the indifference curve as X
increases & Y decreases
• Ratio of the marginal utilities of the goods
Y MU X
MRS
X MUY
10
Slope of an Indifference Curve & the MRS
A
600
Quantity of good Y
C (360,320)
320
I
T’
B
0 360 800
Quantity of good X
11
Two Polar Cases
12
Product Attributes and Indifference
Curves
13
Indifference Map
Quantity of Y
IV
III
II
Quantity of X
14
Marginal Utility
MU U X
15
Consumer’s Budget Line
M PX X PY Y
or
M PX
Y X
PY PY
16
Consumer’s Budget Constraint
17
Typical Budget Line
M
PY
•A
M PX
Y
Quantity of Y
X
PY PY
B
•
M
Quantity of X PX 18
Shifting Budget Lines
R
120
A A
Quantity of Y
Quantity of Y
100 100
F
80
Z B N C B D
160 200 240 125 200 250
Quantity of X Quantity of X
19
Utility Maximization
• The benefits of consumption are described by the
utility function.
• The costs of consumption are described by the budget
constraint.
• Utility maximization subject to a limited money income
occurs at the combination of goods for which the
indifference curve is just tangent to the budget line.
Y MU X PX
MRS
X MUY PY 20
Utility Maximization
MU X MUY
PX PY
21
Constrained Utility Maximization
50
45 •A
40 •B •D
Quantity of pizzas
E IV
30
R
•
III
20
15 •C II
T
10 I
0 10 20 30 40 50 60 70 80 90 100
Quantity of burgers
22
Individual Consumer Demand
23
Deriving a Demand Curve
100
Quantity of Y
Px=$10
Px=$8
Px=$5
0
50 65 90 100 125 200
Quantity of X
10
Price of X ($)
Demand for X
0 50 65 90 24
Quantity of X
Substitution & Income Effects
• When price changes, total change in quantity demanded is
composed of two parts
• Substitution effect
• Income effect
• Substitution effect
• Change in consumption of a good after a change in its price, when
the consumer is forced by a change in money income to consume at
some point on the original indifference curve
• Income effect
• Change in consumption of a good resulting strictly from a change in
purchasing power
25
Income & Substitution Effects: Decrease in
Px
Total effect of = Substitution + Income Total effect of = Substitution + Income
price decrease effect effect price decrease effect effect
9 = 5 + 4 3 = 5 + (-2)
26
Substitution & Income Effects
27
Thank you…!!!
28