1. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 1 Extension Chapter 1 The theory of consumer behaviour

2. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 2 Learning objectives 1.Develop further the two explanations of the law of demand first presented in Chapter 2. 2.Discuss the role of marginal utility in explaining consumer behaviour. 3.Describe the relationship between marginal utility and the demand curve so as to better analyse how consumers allocate their money incomes among various goods and services. 4.Introduce the concept of the budget line and explain the relationship to the price of products and consumer’s income.

3. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 3 Learning objectives (cont.) 5.Develop the concept of indifference curves. 6.Derive a demand curve and demonstrate the law of demand graphically, using indifference curves and budget lines for our analysis 7.Examine the implications of the addition of the time dimension to our explanation of consumer behaviour.

4. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 4 Three explanations of the law of demand 1.Based on income and substitution effects: –Income effect The impact of a change in price on consumers’ real income and quantity demanded –Substitution effect The impact of a change in price on relative expenses and quantity demanded

5. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 5 Three explanations of the law of demand (cont.) 2.Based on utility theory: utility is the satisfaction a consumer obtains from consuming a good or service. –Total utility (TU) is a measure (in units called utils) of the total satisfaction derived from the consumption of a good. –Marginal utility (MU) is the extra satisfaction derived from the consumption of one additional unit of a good.

6. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 6 Three explanations of the law of demand (cont.) 3.Law of diminishing marginal utility: marginal utility will decline as the consumer acquires additional units of a particular product.

7. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 7 Total and marginal utility 0 1 2 3 4 5 6 7 Units consumed 30 20 10 Total Utility (utils) Marginal Utility (utils) 8 6 4 2 0–2 8 6 4 2 0–2 TU MU 1 2 3 4 5 6 7

8. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 8 Theory of consumer behaviour Assumptions –Rational behaviour –Preferences (tastes) –Budget constraint –Prices Utility-maximising rule –Consumer should allocate money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility.

9. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 9 Utility-maximising combination

10. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 10 An algebraic restatement of the utility-maximisation rule MU of product AMU of product B Price of APrice of B =

11. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 11 Marginal utility and the demand curve Deriving the demand curve –Preferences or tastes –Money income –Prices of other goods Create a demand schedule from the purchase decisions as the price of the product is varied

12. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 12 Indifference curve analysis The budget line Shows the various combinations of two products that can be purchased with a given money income Assume two products, A and B. Price of A is $1.50 per unit; price of B is $1.00 per unit. Total money income = $12.00. Various combinations of A and B, as illustrated in the following table …

13. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 13 8 0$12 6 3 12 4 6 12 2 9 12 0 12 12 Units of A price $1.50 Units of B price $1.00 Total expenditures Combination of A and B obtainable with and income of $12

14. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 14 The budget line The budget line shows the combinations of A and B obtainable given money income and prices. An increase in income makes the purchase of more of either or both items possible. Price changes cause a change in the quantity demanded of the items.

15. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 15 (Attainable) A consumer’s budget line Quantity of A Quantity of B (Unattainable) 12 10 8 6 4 2 0 2 4 6 8 10 12 Income/P A = 8 Income/P B = 12

16. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 16 Indifference curves An indifference curve shows all combinations of products A and B that will yield the same level of satisfaction or utility to the consumer.

17. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 17 An indifference schedule j 12 2 k 6 4 l 4 6 m 3 8 Combination Units of AUnits of B

18. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 18 I A consumer’s indifference curve Quantity of A Quantity of B k l m 12 10 8 6 4 2 0 2 4 6 8 10 12 j

19. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 19 Characteristics of indifference curves Down-sloping Convex to origin Slope of indifference curve is the marginal rate of substitution (MRS) Indifference map is a set of indifference curves Curves further away from the origin indicate a higher level of utility

20. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 20 Indifference map 12 10 8 6 4 2 0 2 4 6 8 10 12 Quantity of A Quantity of B I1I1 I2I2 I3I3 I4I4

21. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 21 Equilibrium Equilibrium occurs at point of maximum total utility (TU) Tangency solution –Maximum TU is where highest indifference curve just touches the budget line.

22. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 22 Consumer’s equilibrium Quantity of A Quantity of B I1I1 I2I2 I3I3 I4I4 w x 12 10 8 6 4 2 0 2 4 6 8 10 12 z Y

23. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 23 Deriving the demand curve Assume the price of one good falls –The budget line pivots towards the origin of the axis of the good whose price has fallen. –The equilibrium position changes. The new equilibrium involves more of the good whose P has fallen –This is the law of demand.

24. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 24 Deriving the demand curve (cont.) Quantity of B I1I1 I3I3 2 4 6 8 10 12 12 10 8 6 4 2 0 Quantity of B 1 2 3 4 5 6 7 8 9 10 11 12 $1.50 1.00 0.50 D Price of B Quantity of A

25. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 25 The time dimension The theory of consumer choice has been generalised by taking into account the time required for the consumption of various goods and services. To account for time we must add the value of time required for consumption of each product to the market price of that product Value of wages foregone can be used to value the time used.

26. Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides prepared by George Bredon E1- 26 Next chapter Extension Chapter 2 International trade and protection