1 Microeconomics Consumer Behavior Pertemuan ke-6-7 Consumer Behavior Pertemuan ke-6-7

2 Consumer Behavior There are three steps involved in the study of consumer behavior. 1) We will study consumer preferences. To describe how and why people prefer one good to another. 2)Then we will turn to budget constraints. People have limited incomes. 3) Finally, we will combine consumer preferences and budget constraints to determine consumer choices. What combination of goods will consumers buy to maximize their satisfaction?

3 Consumer Preferences A market basket is a collection of one or more commodities. One market basket may be preferred over another market basket containing a different combination of goods. Three Basic Assumptions 1) Preferences are complete (A to B, B to A or A>B, B>A) 2) Preferences are transitive (A to B to C, A>B>C) 3) Consumers always prefer more of any good to less. ( Semua barang baik) Market Baskets

4 Consumer Preferences A2030 B1050 D4020 E3040 G1020 H1040 Market BasketUnits of Food Units of Clothing

5 Consumer Preferences Indifference curves : semua kombinasi market basket yang memberikan tingkat kepuasan yang sama kepada seseorang tanpa peduli terhadap market basket pada titik manapun. – Indifference curves slope downward to the right. If it sloped upward it would violate the assumption that more of any commodity is preferred to less.  Any market basket lying above and to the right of an indifference curve is preferred to any market basket that lies on the indifference curve. An indifference map is a set of indifference curves that describes a person’s preferences for all combinations of two commodities. – Each indifference curve in the map shows the market baskets among which the person is indifferent. Indifference Curves – Finally, indifference curves cannot cross. This would violate the assumption that more is preferred to less. Indifference Curves

6 The consumer prefers A to all combinations in the blue box, while all those in the pink box are preferred to A. Consumer Preferences Food (units per week) Clothing (units per week) 50 G A EH B D

7 U1U1 Combination B,A, & D yield the same satisfaction E is preferred to U 1 U 1 is preferred to H & G Consumer Preferences Food (units per week) Clothing (units per week) 50 G D A E H B

8 U2U2 U3U3 Consumer Preferences Food (units per week) Clothing (units per week) U1U1 A B D Market basket A is preferred to B. Market basket B is preferred to D.

9 U1U1 U2U2 Consumer Preferences Food (units per week) Clothing (units per week) A D B The consumer should be indifferent between A, B and D. However, B contains more of both goods than D. Indifference Curves Cannot Cross

10 Consumer Preferences Ordinal Versus Cardinal Utility – Ordinal Utility Function: places market baskets in the order of most preferred to least preferred, but it does not indicate how much one market basket is preferred to another. – Cardinal Utility Function: utility function describing the extent to which one market basket is preferred to another.

11 Consumer Preferences Ordinal Versus Cardinal Rankings – The actual unit of measurement for utility is not important. – Therefore, an ordinal ranking is sufficient to explain how most individual decisions are made.

12 Consumer Preferences The marginal rate of substitution (MRS) quantifies the amount of one good a consumer will give up to obtain more of another good. – It is measured by the slope of the indifference curve. We will now add a fourth assumption regarding consumer preference: –Along an indifference curve there is a diminishing marginal rate of substitution. Note the MRS for AB was 6, while that for DE was 2. Indifference curves are convex because as more of one good is consumed, a consumer would prefer to give up fewer units of a second good to get additional units of the first one. Consumers prefer a balanced market basket Perfect Substitutes and Perfect Complements – Two goods are perfect substitutes when the marginal rate of substitution of one good for the other is constant. – Two goods are perfect complements when the indifference curves for the goods are shaped as right angles. Marginal Rate of Substitution

13 Consumer Preferences Food (units per week) Clothing (units per week) A B D E G MRS = 6 MRS = 2

14 Consumer Preferences Orange Juice (glasses) Apple Juice (glasses) Perfect Substitutes Perfect Substitutes

15 Consumer Preferences Right Shoes Left Shoes Perfect Complements Perfect Complements

16 Consumer Preferences These consumers are willing to give up considerable styling for additional performance Styling Performance Consumer Preference A: High MRS Consumer Preference A: High MRS

17 Consumer Preferences These consumers are willing to give up considerable performance for additional styling Styling Performance Consumer Preference B: Low MRS Consumer Preference B: Low MRS

18 Budget Constraints Preferences do not explain all of consumer behavior. Budget constraints also limit an individual’s ability to consume in light of the prices they must pay for various goods and services. The Budget Line – The budget line indicates all combinations of two commodities for which total money spent equals total income. The Budget Line – Let F equal the amount of food purchased, and C is the amount of clothing. – Price of food = P f and price of clothing = P c – Then P f F is the amount of money spent on food, and P c C is the amount of money spent on clothing.

19 Budget Constraints A040$80 B2030$80 D4020$80 E6010$80 G800$80 Market BasketFood (F) Clothing (C)Total Spending P f = ($1)P c = ($2)P f F + P c C = I

20 Budget Line F + 2C = $ (I/P C ) = 40 Budget Constraints Food (units per week) = (I/P F ) A B D E G Clothing (units per week ) Pc = $2 P f = $1 I = $80

21 Budget Constraints The Effects of Changes in Income and Prices – Income Changes A decrease in income causes the budget line to shift inward, parallel to the original line (holding prices constant). – Price Changes If the price of one good increases, the budget line shifts inward, pivoting from the other good’s intercept. If the price of one good decreases, the budget line shifts outward, pivoting from the other good’s intercept.

22 Budget Constraints Food (units per week) Clothing (units per week) A increase in income shifts the budget line outward (I = $160) L2L2 (I = $80) L1L1 L3L3 (I = $40) A decrease in income shifts the budget line inward

23 Budget Constraints Food (units per week) Clothing (units per week) (P F = 1) L1L1 An increase in the price of food to $2.00 changes the slope of the budget line and rotates it inward. L3L3 (P F = 2) (P F = 1/2) L2L2 A decrease in the price of food to $.50 changes the slope of the budget line and rotates it outward.

24 Consumer Choice Therefore, it can be said that satisfaction is maximized where:

25 Consumer Choice It can be said that satisfaction is maximized when marginal rate of substitution (of F and C) is equal to the ratio of the prices (of F and C).

26 Consumer Choice Food (units per week) Clothing (units per week) U1U1 B Budget Line Pc = $2 P f = $1 I = $80 Point B does not maximize satisfaction because the MRS (-(-10/10) = 1 is greater than the price ratio (1/2). -10C +10F

27 Consumer Choice Budget Line U3U3 D Market basket D cannot be attained given the current budget constraint. Pc = $2 P f = $1 I = $80 Food (units per week) Clothing (units per week)

28 U2U2 Consumer Choice Pc = $2 P f = $1 I = $80 Budget Line A At market basket A the budget line and the indifference curve are tangent and no higher level of satisfaction can be attained. At A: MRS =P f /P c =.5 Food (units per week) Clothing (units per week)

29 Designing New Automobiles (II) Styling Performance $10,000 $3,000 These consumers are willing to trade off a considerable amount of styling for some additional performance $7,000

30 Pilihan (Choice) dan Utilitas “Individu cenderung memilih barang yang nilainya paling tinggi, maka individu akan melakukan pilihan- pilihan yang terbaik menurutnya” Dampak memilih barang yang memiliki nilai tinggi agar tingkat kepuasan individu tercapai (utilitas) Utility is the satisfaction, or reward, a product yields relative to its alternatives. The basis of choice. Marginal utility is the additional satisfaction gained by the consumption or use of one more unit of something. Consumer Preferences

31 Consumer Choice A corner solution exists if a consumer buys in extremes, and buys all of one category of good and none of another. – This exists where the indifference curves are tangent to the horizontal and vertical axis. – MRS is not equal to P A /P B A Corner Solution

32 A Corner Solution Ice Cream (cup/month) Frozen Yogurt (cups monthly) B A U2U2 U3U3 U1U1 A corner solution exists at point B.

33 Consumer Choice Suppose Jane Doe’s parents set up a trust fund for her college education. Originally, the money must be used for education. If part of the money could be used for the purchase of other goods, her consumption preferences change. A College Trust Fund

34 The trust fund shifts the budget line Consumer Choice P Q Education ($) Other Consumption ($) U2U2 A College Trust Fund A U1U1 A: Consumption before the trust fund B B: Requirement that the trust fund must be spent on education C U3U3 C: If the trust could be spent on other goods

35 Revealed Preferences If we know the choices a consumer has made, we can determine what her preferences are if we have information about a sufficient number of choices that are made when prices and incomes vary.

36 B is preferred to all market baskets in the green area Revealed Preferences-- Two Budget Lines l2l2 B l1l1 D A All market baskets in the pink shaded area are preferred to A. Food (units per month) Clothing (units per month)

37 All market baskets in the pink area preferred to A Food (units per month) Revealed Preferences-- Four Budget Lines Clothing (units per month) l1l1 l2l2 l3l3 l4l4 A: preferred to all market baskets in the green area E B A G I 3 : E revealed preferred to A I 4 : G revealed preferred to A

38 Marginal utility measures the additional satisfaction obtained from consuming one additional unit of a good. Example – The marginal utility derived from increasing from 0 to 1 units of food might be 9 – Increasing from 1 to 2 might be 7 – Increasing from 2 to 3 might be 5 Observation: Marginal utility is diminishing Marginal Utility and Consumer Choice Marginal Utility

39 The principle of diminishing marginal utility states that as more and more of a good is consumed, consuming additional amounts will yield smaller and smaller additions to utility. Diminishing Marginal Utility Marginal Utility and Consumer Choice

40 Marginal Utility and the Indifference Curve – If consumption moves along an indifference curve, the additional utility derived from an increase in the consumption one good, food (F), must balance the loss of utility from the decrease in the consumption in the other good, clothing (C). Marginal Utility and Consumer Choice

41 Formally: Marginal Utility and Consumer Choice

42 Rearranging: Marginal Utility and Consumer Choice

43 Because: Marginal Utility and Consumer Choice

44 When consumers maximize satisfaction the: Marginal Utility and Consumer Choice Since the MRS is also equal to the ratio of the marginal utilities of consuming F and C, it follows that:

45 Which gives the equation for utility maximization: Marginal Utility and Consumer Choice

46 Total utility is maximized when the budget is allocated so that the marginal utility per dollar of expenditure is the same for each good. This is referred to as the equal marginal principle. Marginal Utility and Consumer Choice

47 Nonprice rationing is an alternative to market rationing. Under one form everyone has an equal chance to purchase a rationed good. Gasoline is rationed by long lines at the gas pumps. Gasoline Rationing Marginal Utility and Consumer Choice

48 Rationing hurts some by limiting the amount of gasoline they can buy. This can be seen in the following model. It applies to a woman with an annual income of $20,000. The horizontal axis shows her annual consumption of gasoline at $1/gallon. The vertical axis shows her remaining income after purchasing gasoline. Marginal Utility and Consumer Choice

49 B 20,000 A Gasoline (gallons per year) Spending on other goods ($) 20,000 5,000 U1U1 C 15,000 2,000 D With a limit of 2,000 gallons, the consumer moves to a lower indifference curve (lower level of utility). 18,000 U2U2 Marginal Utility and Consumer Choice