Notesale: Turn your study into money

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Consumer Behavior
Chapter 8 and Chapter 9
The consumer behavior is concerned with how the consumer chooses to allocate their
income on all the goods and services they prefer to buy
...
The consumer will consider buying the goods they want and can afford
...

The consumer will spend their income in a way that maximizes their total utility
...
Consumption Possibilities and Budget
First the consumer will find the quantities that they can afford to buy and then will decide
what quantities will best satisfy them
...

Example:
If the consumer has $40 income
...
The price of
a movie is $8 and the price of a soda is $4
...

Budget Equation
This is a mathematical presentation addressing the problem of how much can the
consumer buy
...
This can be
translated to:
Income = [(Price of good 1 X Quantity of good 1) + (Price of good 2 X Quantity of good
2)]
In this example good 1 is movies and good two is soda, then
40 = 8Qmovies + 4Qsoda
we leave the quantities of both good as variables and not constants because we still don’t
know how the consumer will allocate their income
...
For example if we
set the quatity of movies to zero then,
40 = (8x0) + 4 Qsoda then,
40 = 4 Qsoda
Qsoda = 40/4 = 10 sodas
...


We can repeat this process by increasing the quantity of movies by one unit and then
solve for the quantity of soda
...

And do the same for Qmovies = 2,3,4 and we will reach that the maximum is 5 movies
...
This means consumption possibility A is calculated by the real income in
terms of soda: Income / Pricesoda and the consumption possibility F is calculated by the
real income in terms of movies: Income / Pricemovie
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Real Income in terms of soda means
that the consumers income can be equivalently described as 10 sodas or $40
...
From price can calculate the
opportunity cost or the amount a consumer must give up from one good to buy an
additional unit of another
...
Price of movie / price of Soda is the relative price of movie, or the opportunity cost
of one movie
...

An easier way to get the consumption possibilities is generated from the relative price
and real income operations
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Any additional movie will cost $8
...

From the previous information we know that the consumer can buy
-Zero movies and 10 sodas (real income)
-If they want an extra movie they will have to give up 2 sodas, which means they can buy
1 movie and 8 sodas
-an additional movie means
2 movies and 6 sodas
and so on, increase 1 and decrease 2 for the other until reaching the real income in terms
of movies
There’s a negative relationship between both quantities because the consumer is limited
by the income and prices of the goods
...
If income
increases this means the quantities for both goods will increase
...
If
the price of one good changes this means that the real income of only that good will
change, the quantities of only that good will change and the relative price will also
change
...
In this example we will plot the quantity of movies on
the x-axis and the quantity of soda on the y-axis
...
The line is
downward sloping
...

An increase in income will shift the line out because the real income for both goods will
increase
...
If the income decreases the budget line will
shift in with the same slope
...
The line will not move from the y- intercept because the real income in terms of
soda did not change
...
If the price of movie decreased this will
cause the budget line to rotate out from the x- intercept, the real income in terms of
movies will increase and the slope will decrease and the line will be flatter
...
If the
price of soda decreased, the budget line will rotate out from the y-intercept, the real
income in terms if soda will increase, the budget line will become steeper and the slope
will increase
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2
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Total utility depends on the level of consumption—more
consumption generally gives more total utility
...
If the quantity consumed increases the
marginal utility of that good decreases
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Quantity
0
1
2
3
4
5
6
7
8
9
10
11

TU Movies
0
50
90
122
150
176
200
222
242
259
275
288

MU Movies TU Soda
0
50
75
40
123
32
159
28
183
26
205
24
225
22
238
20
248
17
255
16
260
13
264

MU Soda
75
48
36
24
22
20
13
10
7
5
4

The marginal utility numbers appear midway between the quantities of soda because it is
the change in the quantity bought that produces changes in the marginal utility
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Positive
Marginal Utility All the things that people enjoy and want more of have a positive
marginal utility
...
Two examples are hard labor and polluted air
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Thus total utility increases as the quantity consumed increases, marginal utility is
the rate of change and total utility increases at a decreasing rate
...


To calculate marginal utility: change in TU / change in quantity
Marginal utility for the 6th soda: (225-205) / (6-5) = 20 / 1 = 20 utility units for increasing
the soda from the 5th to the 6th
Marginal utility for the 7th soda: (238-225) / (7-6) = 13 / 1 = 13 utility units for increasing
soda from the 6th to the 7th, MU decreases but TU increases
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If the consumer is buying total of 4 movies and 4 sodas then they will
receive 150 total utility for the 4 movies AND 183 total utility for the 4 sodas, then they
get total utility of 150 + 183 = 333 total utilities from both
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If we find all possible quantities of both goods that give the same
total utility, then the consumer will be indifferent among those quantities
...
An
indifference curve has all quantities of two goods that give the same level of utility and
thus the consumer is indifferent among those quantities
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For example:
If the quantities the consumer is buying are 10 movies and 7 sodas (point w: 10 movies
and 7 sodas) then they will receive total utility of 275 + 238 = 513 utilities from both
goods
...
this means that (point w)10 movies and 7 sodas is on
a lower indifference curve compared to (point y) 11 movies and 7 sodas
...

Point
W
Y
Z
•
•

Quantity Movies
10
11
11

Quantity Soda
7
7
6

Total Utility
275 + 238 = 513
288 + 238 = 526
288 + 225 = 513

Point w and z are on the same indifference curve
...

Point y is in a higher indifference curve because the total utility is higher

Marginal Rate of Substitution (MRS)
Moving along the same indifference curve means, all different quantities of both goods
that give the same total utility, so every time we increase the quantity of a good by one
unit we will have to give up some quantity of the other good so that the curve shows the

same level of total utility
...
This means the indifference curve shows a negative
relationship between the two goods, so the curve has a negative slope and is downward
sloping
...
The slope
of the indifference curve is called the marginal rate of substitution (MRS)
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• When the quantity of movies is low and quantity of soda is high the MRS is high
and the curve is steep
• When the quantity of movies is high and quantity of soda is low the MRS is low
and the curve is flat
consumption possibilities and indifference curve:
-Now the consumer knows all the quantities they can afford for both goods and know the
utility, then they will choose the highest utility
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Consumption
Possibility
A
B
C*
D
E
F

Quantity of Movies

Quantity of Soda

Total Utility

0
1
2*
3
4
5

10
8
6*
4
2
0

0 + 260 = 260
50 + 248 = 298
90 + 225 = 315 *
122 + 183 = 305
150 + 123 =273
176 + 0 = 176

-Each point is on a different indifference curve because each point gives a different utility
level
-The order of the IC of each point from lowest to highest:
Indifference Curve F, Indifference Curve A, Indifference Curve E, Indifference Curve B,
Indifference Curve D, Indifference Curve C
...

-The highest affordable indifference curve is tangent to the budget line, all other
indifference curves go through the budget line
-At point C the slope of the budget line is equal to the slope of the indifference curve,
Relative Price of movies = MRS = 2
- At point A and point B the MRS ˃ Relative Price
- At point D, point E and point F the MRS < Relative Price
-The highest affordable indifference curve has only one affordable points, all other
indifference curves have several points on the budget line and below the budget line
Using Marginal Analysis:
If we consider the consumption possibilities and the marginal utility then we can say that
the consumer will choose to pay the price of an additional unit that gives relatively high
marginal utility
...
This means the decision can
be translated as: if they have an additional dollar, would they prefer increasing the
quantity of movie or soda
...
Marginal utility per dollar = MU/price
For marginal analysis we always use consumption possibilities with quantities higher
than zero, so we don’t calculate point A and F
Example:
-For any unit the consumer pays $8 for a movie and $4 for a soda
-At point B the consumer buys 1 movie and 8 sodas
-Movie(1 unit and MU1st: 50, price $8)
consumer paid for the 1st movie $8 and received the marginal utility of the 1st movie
which is 50 utility
...
25 utilities:
because MU/price 50 / 8= 6
...
For each dollar he paid for the 8th unit he received 2
...
50
-If he buys more movies then MU movies will decrease, he must buy less soda and MU
soda will increase
...
point C is the
consumer equilibrium where the marginal utility per dollar for both goods are equal and
the consumer achieves the highest total utility
...
25 ˃
40/8= 5 equal
32/8=4
<
28/8=3
...
5
20/4=5*
24/4= 6
48/4=12

Change in Price
If the price of movies decreases from $8 to $4 then
The consumption possibilities will change because the consumer will be able to afford
more movies
...


Consumption
Possibility

Quantity
of Movies

G
H
I
J
K
L
M*
N
O
P
Q

0
1
2
3
4
5
6*
7
8
9
10

Quantity Marginal Utility per
of Soda dollar
MU/Price
10
XXXXXXXX
9
50/4=12
...
75
8
40/4= 10
˃ 10/4=2
...
25
6
28/4=7
˃
20/4=5
5
26/4=6
...
5
4*
24/4=6 *equal* 24/4=6
3
22/4=5
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25 < 75/4=18
...
From this information we can derive the demand
curve for movies that shows the relationship between price of movies and the quantity of
movies that maximizes total utility
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The
previous example shows that the price effect that maximizes total utility follows the law
of demand
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Substitution Effect:
It is the effect of a change in price on the quantity when the consumer remains indifferent
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So we find a point on the original indifference
curve that has the same slope as the new consumer equilibrium
...
The
change from the old quantity to that quantity is the substitution effect
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