Chapter 6 theory of Consumer behavior

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Chapter 6 theory of Consumer behavior
Chapter 2 talks about market demand, but market is made of many individuals with different incomes, tastes, etc. Individual consumer is assumed to be rational and wish to maximize his/her well-being.

In this chapter you will encounter:
Indifference curve The marginal rate of substitution (MRS) The concept of utility The budget line The equilibrium market basket Deriving individual demand curve and market demand curve

6.1Consumer preferences and utility
Complete information Preference ordering

The concept of utility Why people consumer?
To satisfy their unlimited desire, to be satisfactory. Utility indicated the level of enjoyment or preference attached by this consumer to this market baskets.

utility The utility Function
Benefits consumers obtain from the goods and services they consume.

Cardinal Utility & Ordinal Utility
Cardinal utility believes that utility could be measured & added (utility unit & marginal analysis); Ordinal utility holds that utility could only be ordered and cannot be measured (indifference curve).

Cardinal utility Total & Marginal Utility
Total utility (TU）refers the degree of satisfaction from the whole consumption Marginal utility（MU）refers the additional satisfaction from one more unit of consumption

Law of Diminishing Utility
As more of a product is consumed, the degree of satisfaction consumers get from every additional unit is decreasing. Marginal utility (MU) is decreasing. The law of diminishing utility.

Ordinal utility Ordinal utility holds that utility cannot be measured but can be ordered according to consumers’ preferences. Different product combinations may be viewed as having same utility, And these combinations of same utility consist of one Indifference Curve (IC).

6.2 Indifference Curve Indifference Curve (IC) contains points representing market baskets among which the consumer is indifferent.

indifference curve A locus of points representing different bundles of goods and services, each of which yields the same level of total utility.

Indifference curve（IC） Increasing satisfaction
X2 I3 I2 I1 O X1

The important things of IC
IC is convex to the origin. Every indifference curve must (?) slope downward and to the right; Indifference curves cannot intersect.

Another important but not mentioned thing about IC:
A consumer has many indifference curves; How do you understand this attribute?

X1 X2 ΔX1=1 ΔX2 O IC U = f（X1，X2）= U1 A ΔX2 /ΔX1 B C

Marginal Rate of Substitution (MRS)
MRS is defined as the number of units of good Y that must be given up if consumer is to receive an extra unit of good X and to maintain a constant level of satisfaction.

To calculate MRS

Not all indifference curves must slope downward.
Can you name some other cases? What will the IC of substitutes & complements?

IC of substitutes X1 X2 I2 I1 O

IC of compliments X1 X2 I2 I1

6.2.4A Marginal Utility Interpretation of MRS
ΔU=(MUxX Δ X)+(MUyX Δ Y)=O - ΔY/ ΔX=Mux/Muy MRS= Mux/Muy

The budget line Consumers want to be most satisfactory, but to be constrained by their income (budget). Budget refers to various possible combinations of products that consumers can buy when their income & products’ prices are set.

The budget line X1 X2 I / P2 I / P1 Budget Space

Variation of budget line
Discuss P1& P2 hold constant while I changes; I holds constant while P1&P2 change proportionately; I holds constant while P1 or P2 changes; I, P1&P2 increase or decrease proportionately at the same time.

“I” changes X2 I / P2 I decrease I increase X1 I / P1

P1 increases P1 decreases
P1 changes X2 I / P2 P1 increases P1 decreases X1 I / P1

Question What if P2 changes ? And I, P1 & P2 change?

Consumers want to be most satisfactory; But they are constrained by their income (budget). Consumers (rational) want to maximize their utility with limited income.

Budget line & Indifference curve
X1 X2 O Discuss: How do you understand E? B E I2 I1 C I3

6.4.2marginal utility interpretation of equilibrium

Consumer Equilibrium

Given the Utility function as follows,
Problem Try to find Utility Maximization consumer basket. Given the Utility function as follows, And PX=PY=1 while Income=100。 Try to find Utility Maximization consumer basket.

Concluding remarks Consumer basket is determined by both prices of product & his / her income. What if only prices change? What if only income changes?

Price-Consumption curve
If only prices change Price changes → PCC X Y O I2 I3 I1 E2 E3 E1 XE1 XE2 XE3 PCC Price-Consumption curve

If only income changes Income changes → ICC ICC Y O X I2 I3 I1 E2 E3
XE1 XE2 XE3 A1 A2 A3 Income changes → ICC ICC

Deriving individual demand curve
A consumer’s demand curve shows how much he or her will purchase of the goods in question at various prices of this good (when other prices and the consumer’s income are held constant).

PCC to Consumer Demand Curve
X Y O I2 I3 I1 E2 E3 E1 XE1 XE2 XE3 PCC X PX XE1 XE2 XE3 PE1 PE2 PE3 X = f（PX） Consumer Demand curve

In fact, we could get Demand Curve from Utility Function.
Given income (I) and Utility function as follows, Try to get the consumer demand curve.

To get market demand curve
Summing individual consumer demand curve horizontally we get the market demand curve.

Q Total market P Q1 Q2 Q=QA+QB Consumer A Consumer B Q1+Q2

The law of demand There is an inverse relationship between the price of a good and the quantity demanded assuming all other factors that might influence demand are held constant.

Consumer surplus Consumer Surplus (proposed by Marshell) is the excess of the price which a person would be willing to pay rather than go without the good over that which he actually does pay.