1. Introduction to Consumer Behavior
Flashcards
- What does the theory of consumer behavior investigate?
- Why consumers make purchases.
- What is utility?
- A measure of how 'satisfied' consumers are.
- What are the four assumptions over consumer preferences?
- Completeness and rankability, more is better, transitivity, and diminishing marginal utility.
- What does an indifference curve represent?
- All consumption bundles that provide the same level of utility.
Multiple-choice questions
- What is the primary assumption economists make about consumers?
- a) Consumers are irrational and make random decisions.
- b) Consumers are rational and aim to optimize consumption decisions.
- c) Consumers are easily influenced by advertising.
- d) Consumers have unlimited resources for consumption.
Answer: b) Consumers are rational and aim to optimize consumption decisions.. Economists assume that consumers are rational and strive to optimize their consumption decisions given their limited resources.
- Which of the following is NOT an assumption about consumer preferences?
- a) Completeness and rankability
- b) More is better than less for most goods
- c) Transitivity in rankings
- d) Consumers always prefer less of a good to more
Answer: d) Consumers always prefer less of a good to more. One of the main assumptions is that for most goods, consumers prefer more to less (non-satiation).
- What does 'diminishing marginal utility' refer to?
- a) The more a consumer has of a good, the more they want of it.
- b) The more a consumer has of a good, the less willing they are to give up something else for even more of it.
- c) The consumer's utility increases linearly with consumption.
- d) Utility remains constant regardless of consumption.
Answer: b) The more a consumer has of a good, the less willing they are to give up something else for even more of it.. Diminishing marginal utility means that as a consumer obtains more of a particular good, they become less willing to sacrifice other goods to obtain even more of that good.
2. The Consumer's Preferences and the Concept of Utility
Flashcards
- What is utility in microeconomics?
- A measure of how satisfied a consumer is.
- What is a utility function?
- A relationship between consumption and well-being.
- What is marginal utility?
- Additional utility from one more unit of a good.
- What is an indifference curve?
- Bundles providing the same utility level.
Multiple-choice questions
- What does a utility function describe?
- a) The relationship between consumer consumption and well-being.
- b) The total income of all consumers in a market.
- c) The government regulations on consumer products.
- d) The stock market performance of consumer goods companies.
Answer: a) The relationship between consumer consumption and well-being.. A utility function specifically outlines how a consumer's level of well-being is related to their consumption of goods and services.
- What is marginal utility?
- a) The total satisfaction from consuming all goods.
- b) The additional utility from consuming one more unit of a good.
- c) The average utility derived from all goods consumed.
- d) The minimum utility required to satisfy basic needs.
Answer: b) The additional utility from consuming one more unit of a good.. Marginal utility refers to the extra satisfaction or benefit gained from consuming an additional unit of a product or service.
- What does an ordinal ranking of consumption bundles imply?
- a) Bundles can be ranked from best to worst.
- b) The exact utility derived from each bundle can be quantified.
- c) All bundles provide the same level of utility.
- d) Bundles can only be compared based on price.
Answer: a) Bundles can be ranked from best to worst.. Ordinal ranking means that consumers can compare and rank different bundles of goods in terms of preference, from the most to least desired.
3. Indifference Curves
Flashcards
- What is an indifference curve?
- A curve showing all bundles of goods that give the consumer the same utility.
- What is the Marginal Rate of Substitution (MRS)?
- The rate at which a consumer is willing to trade one good for another.
- What does the slope of an indifference curve represent?
- The Marginal Rate of Substitution (MRS).
- What is the shape of indifference curves for perfect substitutes?
- Relatively straight lines.
Multiple-choice questions
- What does an indifference curve represent?
- a) Consumption bundles that a consumer can afford.
- b) All consumption bundles that provide a consumer with the same level of utility.
- c) The change in utility from consuming an additional unit of a good.
- d) The rate at which a consumer is willing to trade one good for another.
Answer: b) All consumption bundles that provide a consumer with the same level of utility.. An indifference curve plots all consumption bundles that provide a consumer with the same level of utility, meaning the consumer is indifferent between any points on the curve.
- Which of the following is NOT a characteristic of indifference curves?
- a) They can be drawn.
- b) Curves further from the origin represent higher utility.
- c) Curves can cross.
- d) They are convex to the origin.
Answer: c) Curves can cross.. Indifference curves cannot cross because that would violate the assumption of transitivity. If they cross, it would imply a consumer is indifferent between bundles that are not equally preferred, leading to inconsistency.
- What does the Marginal Rate of Substitution (MRS) describe?
- a) The total utility a consumer derives from a bundle of goods.
- b) The rate at which a consumer is willing to trade one good for another while maintaining the same level of utility.
- c) The additional utility a consumer receives from consuming one more unit of a good.
- d) The total cost of a bundle of goods.
Answer: b) The rate at which a consumer is willing to trade one good for another while maintaining the same level of utility.. The MRS describes the rate at which a consumer is willing to trade one good (X) for another good (Y), while remaining equally satisfied (on the same indifference curve).
4. The Consumer's Income and the Budget Constraint
Flashcards
- What is the budget constraint?
- The limit on consumption bundles that a consumer can afford.
- What two factors determine the position and slope of the budget constraint?
- Income and relative prices.
- How does an increase in income affect the budget constraint?
- It shifts the budget constraint outward.
- What does the slope of the budget constraint represent?
- The relative price of the two goods.
Multiple-choice questions
- What does the budget constraint represent?
- a) The consumer's preferences for goods
- b) The limit on how much of a good can be purchased
- c) The bundles a consumer can feasibly purchase given income and prices
- d) The relationship between utility and consumption
Answer: c) The bundles a consumer can feasibly purchase given income and prices. The budget constraint illustrates the combinations of goods and services a consumer can afford with their available income and the market prices of those goods.
- What are the two factors that affect the budget constraint's position?
- a) Consumer preferences and utility
- b) Income and relative prices
- c) Marginal utility and indifference curves
- d) Quantity discounts and quantity limits
Answer: b) Income and relative prices. The budget constraint's position and slope are determined by the consumer's income and the relative prices of the goods they can purchase.
- How does a change in income affect the budget constraint?
- a) It changes the slope of the budget constraint
- b) It pivots the budget constraint
- c) It shifts the budget constraint
- d) It has no effect on the budget constraint
Answer: c) It shifts the budget constraint. A change in income shifts the entire budget constraint, either outward (for an increase in income) or inward (for a decrease in income), without changing its slope.
5. Combining Utility, Income, and Prices: What Will the Consumer Consume?
Flashcards
- What is the definition of Marginal Rate of Substitution (MRS)?
- The rate at which a consumer is ready to give up one good in exchange for another while maintaining the same level of utility.
- What is the significance of the tangency point between an indifference curve and the budget constraint?
- It represents the consumer's optimal choice, where they maximize utility given their income and market prices.
- How do changes in income affect the budget constraint?
- Changes in income shift the budget constraint, altering the affordable consumption possibilities.
- How do changes in the price of a good affect the budget constraint?
- Changes in the price of a good pivot the budget constraint, altering its slope and the affordable quantities of that good.
Multiple-choice questions
- What does the marginal rate of substitution (MRSXY) describe?
- a) The rate at which one is willing to trade X for Y, remaining equally well off.
- b) The total utility derived from consuming goods X and Y.
- c) The budget constraint limiting consumption of goods X and Y.
- d) The point where the indifference curve crosses the budget constraint.
Answer: a) The rate at which one is willing to trade X for Y, remaining equally well off.. The MRSXY describes the rate at which a consumer is willing to trade one good (X) for another good (Y) while maintaining the same level of utility.
- What does the tangency between an indifference curve and the budget constraint represent?
- a) The point where the consumer spends all income on one good.
- b) The consumer's least preferred consumption bundle.
- c) The consumer's optimal choice, maximizing utility given income and prices.
- d) The point where the consumer saves the most money.
Answer: c) The consumer's optimal choice, maximizing utility given income and prices.. The tangency represents the point where the consumer's marginal rate of substitution equals the price ratio, indicating the highest possible utility given the budget constraint.
- What is the key condition for utility maximization?
- a) Marginal utility per dollar spent is equalized across all products.
- b) Total utility is maximized regardless of cost.
- c) Spending all income on the good with the highest marginal utility.
- d) Saving as much income as possible.
Answer: a) Marginal utility per dollar spent is equalized across all products.. Utility maximization occurs when the marginal utility per dollar spent is equalized across all products, ensuring the consumer gets the most satisfaction from their spending.
6. Conclusion
Flashcards
- What are the key elements influencing consumer choice?
- Preferences, prices, and income.
- What is the focus of Chapter 5 in relation to consumer behavior?
- Linking consumer behavior to individual and market demand.
- Define 'preferences' in the context of consumer behavior.
- Underlying desires and tastes of consumers.
- How do 'prices and income' constrain consumer choices?
- By determining what consumers can afford.
Multiple-choice questions
- What are the two primary mechanisms behind consumer choice introduced in this chapter?
- a) Advertising and marketing strategies
- b) Preferences and prices and income
- c) Supply and demand dynamics
- d) Production costs and market competition
Answer: b) Preferences and prices and income. The chapter specifically highlights preferences, prices, and income as the foundational elements influencing consumer decisions.
- In the context of consumer behavior, what is the primary focus of the subsequent chapter (Chapter 5)?
- a) Analyzing production costs
- b) Understanding market competition
- c) Linking consumer behavior to individual and market demand
- d) Exploring government regulations
Answer: c) Linking consumer behavior to individual and market demand. Chapter 5 aims to connect the principles of consumer behavior with the broader concepts of individual and market demand.
- Which of the following best describes the role of 'preferences' in consumer choice, as introduced in the chapter?
- a) They dictate the prices consumers are willing to pay
- b) They represent the underlying desires and tastes of consumers
- c) They are determined solely by income levels
- d) They are shaped exclusively by advertising
Answer: b) They represent the underlying desires and tastes of consumers. Preferences refer to the individual tastes and desires that consumers have, influencing their choices among various goods and services.
And 6 more flashcards and 12 more questions in the document.
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Consumer Behavior Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Topic 1 v. 3.0 Chapter Outline 4.1 The Consumer's Preferences and the Concept of Utility 4.2 Indifference Curves 4.3 The Consumer's Income and the Budget Constraint 4.4 Combining Utility, Income, and Prices: What Will the Consumer Consume? 4.5 Conclusion 4-1 Introduction Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-2 4 How do consumers make purchases?
This chapter introduces a theory of consumer behavior The theory is used to investigate why consumers make purchases Ultimately, consumers are assumed to "optimize" their utility given scarce resources Consumer theory is the basis for the "demand" side of the supply and demand model 4.1 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-3 Economists assume consumers are rational and able to "optimize" consumption decisions given scarce resources Four assumptions over consumer preferences 1. Completeness and rankability Consumers can compare bundles of goods and rank them 2.
For most goods, more is better than less Non-satiation and "free disposal" 3. Transitivity Imposes consistency on rankings 4.
The more a consumer has of a particular good, the less she is willing to give up of something else to get even more of that good Referred to as "diminishing marginal utility" 4 The Consumer's Preferences and the Concept of Utility 4.1 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-4 The Concept of Utility Utility is a measure of how "satisfied" consumers are A measure of happiness or satisfaction Provides a theoretical basis for decision theory A utility function describes the relationship between what consumers actually consume and their level of well-being Common assumptions: continuous, differentiable, concave 4 The Consumer's Preferences and the Concept of Utility 4.1 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-5 The Concept of Utility Consider the utility someone enjoys from seeing a movie in a theater vs.
watching a DVD where T is the number of movies "consumed" at the theater, and D is the number of DVDs consumed at home.
Utility might be represented by In general, movies consumed in the theater add more utility than those consumed at home (this particular functional form is referred to as "Cobb–Douglas": ) 4 The Consumer's Preferences and the Concept of Utility U =U T,D ( ) U =T0.8 D0.2 y x y x U = ) , ( 4.1 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-6 The Concept of Utility Utility is a measure of how "satisfied" consumers are A measure of happiness or satisfaction Provides a theoretical basis for consumer theory A utility function describes the relationship between what consumers actually consume and their level of well-being Common assumptions: continuous, differentiable, concave Marginal utility is the additional utility a consumer receives from an additional unit of a good or service.
4 The Consumer's Preferences and the Concept of Utility 4.1 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-7 The Concept of Utility Continuing the previous example: the marginal utility of theater-movies for this consumer is given by or, analytically, by: Or, with the prescribed parameters 4 The Consumer's Preferences and the Concept of Utility MUT = 0.8T-0.2 D0.2 = Δ , Δ = , 4.1 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-8 Comparing consumption outcomes The "rules" for utility allow for an ordinal ranking of consumption bundles An ordinal ranking implies bundles can be ranked from best to worse A cardinal ranking would allow a person to determine how much better one bundle is, compared to another Why not cardinal?
Many questions can be answered with only an ordinal ranking (predicting what will be consumed) Consumers differ in preferences (both between consumers and over time) 4 The Consumer's Preferences and the Concept of Utility 4.2 Indifference Curves Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-9 Ordinal rankings mean we care about relative outcomes Some bundles are better than others, some are worse Start by considering bundles that are relatively equal A consumer is indifferent between bundles when he or she derives the same utility level from two or more bundles.
An indifference curve plots out all of the consumption bundles that provide a consumer with the same level of utility.
4 4.2 Indifference Curves Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-10 4 Figure 4.1 Building an Indifference Curve Number of friends living in building A 10 B 5 C 3 Indifference curve U 0 500 750 Apartment size (square feet) 1,000 4.2 Indifference Curves Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-11 4 Figure 4.2 A Consumer's Indifference Curve Number of friends living in building 5 U2 U1 0 500 1,000 U2 has a greater utility than U1 Apartment size (square feet) 4.2 Indifference Curves 4-12 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Characteristics of indifference curves 1.
They can be drawn Completeness and rankability 2. Curves further from the origin represent higher utility More is better 3. Curves never cross Transitivity 4. Convex to the origin Diminishing marginal utility 4 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-13 4 Indifference curves can never cross Movies at the theater Call our movie watcher, Joe To see why indifference curves cannot cross, consider bundles D and F These bundles are on the same curve; Joe must be indifferent between them Now, draw another indifference curve through bundle F Implies Joe is also indifferent between points E and F Why must Joe prefer bundle E to bundle F?
E 4.2 Indifference Curves F D DVDs 4.2 Indifference Curves Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-14 4 Figure 4.4 Tradeoffs Along an Indifference Curve Number of friends A living in building B C U1 As apartment size gets larger, Michaela is less willing to trade off the number of friends for additional apartment size.
5 0 500 1,000 Apartment size (square feet) 4.2 Indifference Curves 4-15 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The Marginal Rate of Substitution Indifference curves describe tradeoffs How much of one good are you willing to give up for one more unit of another good The slope of the indifference curve captures this tradeoff We call this slope the marginal rate of substitution Describes the rate at which one is willing to trade X for Y, and be equally well off 4 0 = X Y MRSXY 4.2 Indifference Curves Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-16 4 Figure 4.5 The Slope of an Indifference Curve is the Marginal Rate of Substitution T-shirts A Slope = –2 B Slope = –0.5 U Pairs of socks As you move down an indifference curve, you experience a diminishing marginal rate of substitution 4.2 Indifference Curves 4-17 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The Marginal Rate of Substitution and Marginal Utility Consider point A from the previous figure Sarah is willing to give up two t-shirts for one pair of socks; what does this mean in terms of the change in Sarah's level of utility?
But the change in utility is zero... she is just as well off! Rearranging, and finally: 4 t-shirts socks 2 XY Q Y MRS X Q = = = socks socks t-shirts t-shirts U MU Q MU Q = + t-shirts t-shirts socks socks MU Q MU Q = t-shirts socks socks t-shirts Q MU Q MU = 0 = 4.2 Indifference Curves 4-18 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The Marginal Rate of Substitution and Marginal Utility The MRS between two goods is equal to the inverse of the goods' marginal utilities: Observing the tradeoffs that consumers make provides insight as to the relative marginal utilities of goods!
What does it mean if the slope of an indifference curve is steeper? Flatter?
Steeper curves imply the consumer is willing to give up a lot of Y for a little of X Less steep curves imply the consumer is not willing to give up a lot of Y for a little of X 4 Y X XY MU MU MRS = 4.2 Indifference Curves 4-19 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Figure 4.6 The Steepness of Indifference Curves 4 Example Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-20 4 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-21 figure it out Movie Theater vs.
DVDs Assume Joe's utility function for movies at the theater (T ) and DVDs watched at home (D ) is given by Answer the following questions: 1. Write an equation for MRSTD 2. Would bundles of (T = 2 and D = 2) and (T = 1 and D = 4) be on the same indifference curves? 3. Are Joe's indifference curves convex? (Does MRSTD fall as T rises?) ( ) D MU T MU D T U D T 2 ; 8 4 2 2 = = + = Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-22 figure it out 1. Using the equation for MRS 2.
For bundles to lie on the same indifference curve, they must provide the same level of utility For the first bundle: and the second: The bundles provide the same level of utility; thus, they must lie on the same indifference curve Movie Theater vs. DVDs DVD theater theater DVD 4 TD Q MU T MRS Q MU D = = = ( ) ( ) ( ) 20 2 2 4 2 ; 2 2 2 = + = = = D T U ( ) ( ) ( ) 20 4 1 4 4 ; 1 2 2 = + = = = D T U Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-23 figure it out 3.
To answer this question, calculate MRS at each of the bundles; remember At the second bundle (theater movies are on the x-axis): and at the first So Joe is willing to trade more DVD watching for less theater tickets as he consumes more theater movies... What does this mean? Indifference curves are actually concave, not convex Violates the fourth characteristic of indifference curves! Movie Theater vs.
DVDs DVD theater theater DVD 4 TD Q MU T MRS Q MU D = = = ( ) ( ) theater DVD 4 2 2; 2 4 2 TD MU MRS T D MU = = = = = ( ) ( ) theater DVD 4 1 1; 4 1 4 TD MU MRS T D MU = = = = = 4.2 Indifference Curves 4-24 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The Curvature of Indifference Curves: Substitutes and Complements The shape of indifference curves reveals information about the relationship between products Relatively straight indifference curves describe goods that are more easily substitutable for one another Indifference curves that are more convex to the origin describe goods that are more complementary to one another 4 4.2 Indifference Curves 4-25 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Figure 4.8 The Curvature of Indifference Curves 4 4.2 Indifference Curves 4-26 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The Curvature of Indifference Curves: Substitutes and Complements The shape of indifference curves reveals information about the relationship between products Relatively straight indifference curves imply that the two goods being considered are substitutable to some degree Indifference curves with significant curvature imply a degree of complementarity To illustrate, consider extreme cases Perfect substitutes are goods that can trade with another good in fixed units and receive the same level of utility (constant MRS) Perfect complements are goods that the consumer must consume in a fixed proportion 4 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-27 4 Perfect substitutes 0 1-liter bottles of root beer 2-liter bottles of root beer Consider a typical consumer's preferences for 1- and 2-liter soda bottles This consumer should be willing to trade one 2-liter bottle for two 1-liter bottles no matter how much of each he or she has MRS is constant in this case 1 4.2 Indifference Curves U1 2 3 4 2 8 6 4 U4 U3 U2 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-28 4 Perfect complements 0 Hotdog buns Hotdogs Alternatively, consider preferences for hotdogs and hotdog buns Most consumers will prefer to consume these goods in constant proportion Consider point A ; this consumer has two hotdogs and two buns Adding another hotdog bun (bundle B ) will not increase utility The consumer needs another hotdog as well (bundle C ) if utility is to increase 1 4.2 Indifference Curves U1 2 3 1 3 2 U3 U2 A B C Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-29 4 4.11 The Same Consumer Can Have Indifference Curves with Different Shapes 4.2 Indifference Curves Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-30 figure it out Television Choices Patrick can watch reruns of The Bachelor (TB, in hours) or back to back NFL (American football) games (NFL, in hours).
Watching The Bachelor makes Patrick happy, but he really does not care about football. Draw a diagram showing a set of Patrick's indifference curves for B and N (put B on the horizontal axis). What is Patrick's MRSBN when he is consuming one hour of each show?
Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-31 figure it out Television Choices 0 TB (hours) NFL (hours) Since Patrick is indifferent to hours of NFL, bundles A, B, and C all offer the same level of utility To improve his utility, he must watch another hour of The Bachelor Because the slope of the indifference curve is infinite, MRSBN is also infinite; Patrick is willing to give up an infinite number of hours of NFL for one more hour of The Bachelor 1 U1 2 3 1 3 2 U2 D B C Patrick's preferences for NFL hours and The Bachelor are shown in the graph below: A E Example Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-32 4 4.3 4-33 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The budget constraint for two goods is plotted alongside indifference curves; mathematically, To find the slope of the budget constraint, solve for QY The quotient / represents: the relative price of good X the opportunity cost of consuming X instead of Y 4 The Consumer's Income and the Budget Constraint Y Y x X Q + P Q = P Income Q P P P = Q x Y X Y Y Income 4.3 4-34 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Returning to the socks/t-shirts example, and setting income to $50, the price of socks to $5, and the price of t-shirts to $10 yields Or, graphically, 4 The Consumer's Income and the Budget Constraint Q = Q x Y 2 1 5 4.3 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-35 4 Figure 4.14 The Budget Constraint The Consumer's Income and the Budget Constraint T-shirts B I Py 4 Infeasible C 3 Px 2 Slope = - = 5/10= 1/2 Py Feasible 1 A 0 2 4 6 8 I socks Px Pairs of = 5 = 10 Slope is negative because purchasing more socks means less income for t-shirts.
Why does the budget constraint slope downward?
4.3 4-36 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Factors that Affect the Budget Constraint's Position The slope and position of the budget constraint are a function of two factors: income and relative prices Changes in income shift the budget constraint by changing the intercept Changes in the price of one good pivots the budget constraint by changing the slope Consider again the budget constraint for socks and t-shirts 4 The Consumer's Income and the Budget Constraint 4.3 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-37 4 Figure 4.15 The Effects of Price or Income Changes on the Budget Constraint The Consumer's Income and the Budget Constraint (a) (b) (c) T-shirts T-shirts T-shirts Old budget Old budget Old budget B B B 5 5 5 constraint constraint constraint New budget New budget New budget constraint with higher constraint with higher 4 4 4 constraint with price for socks price for t -shirts lower income 3 3 3 B' B' Loss of feasible Loss of feasible Loss of feasible bundles bundles bundles 2 2 2 1 1 1 Feasible Feasible Feasible bundles bundles bundles A' A A A' A 0 0 0 2 4 6 8 10 2 4 6 8 10 2 4 6 8 10 Pairs of socks Pairs of socks Pairs of socks Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-38 figure it out Television Choices James has $40 per week he can spend on movie tickets (M) at $10 dollars each or burritos (B) at $5 each.
a. Write an equation for James's budget constraint and draw it on a graph that has burritos on the horizontal axis b. Suppose the price of burritos rises to $8.
Draw James's new budget constraint Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-39 figure it out Television Choices The budget constraint represents bundles James can feasibly purchase, and takes the form: Since we are putting burritos on the horizontal axis, we want to find an equation for M as a function of B, or To find the new budget constraint, simply change the price of burritos to $8 Since the price of movie tickets has not changed, we know the budget constraint will pivot inward, to a new horizontal intercept of 5 burritos 0 Burritos Movie tickets 1 2 3 4 2 8 6 4 BC1 BC2 M B M B + P = P M B 10 5 40 Income + = B M B M 5 .
0 4 5 40 10 = = 4.3 4-40 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Nonstandard Budget Constraints Quantity discounts Sometimes, consumers may secure a discounted price if a minimum quantity of a good is purchased (e.g., buy two, get one free) This results in a kink in the budget constraint 4 The Consumer's Income and the Budget Constraint 4.3 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-41 4 Figure 4.16 Quantity Discounts and the Budget Constraint The Consumer's Income and the Budget Constraint Phone minutes 1,400 5 cents/minute Infeasible Feasible 1,000 600 10 cents/minute Feasible 0 4 10 Pizzas 100 1 .
0 10 : 600 = + t z t 100 ) 600 ( 05 . 0 600 1 . 0 10 : 600 = + + t z t 70 05 .
0 10 : 600 = + t z t I =100, Pz =10, Pt =0.1 4.3 4-42 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Nonstandard Budget Constraints Quantity discounts Sometimes, consumers may secure a discounted price if a minimum quantity of a good is purchased (e.g., buy two, get one free) This results in a kink in the budget constraint Quantity limits Alternatively, there may be limits on how much of a good can be purchased (e.g., gasoline in the 1970s) 4 The Consumer's Income and the Budget Constraint 4.3 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-43 4 Figure 4.17 Quantity Limits and the Budget Constraint The Consumer's Income and the Budget Constraint Phone minutes 1.400 Infeasible 1.000 600 10 cents/minute Feasible 0 4 10 Pizzas Infeasible 100 1 .
0 10 : 600 = + t z t I =100, Pz =10, Pt =0.1 4.4 4-44 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e The concepts of utility and indifference curves describe consumer preferences; the budget constraint describes which bundles are feasible Combining these concepts, we can begin to understand consumer choices Solving the Consumer's Optimization Problem Consumers face a constrained optimization problem Maximize utility, subject to income and market prices ቊ ( , ) . . + The optimal choice can be interpreted most easily using a graph 4 Combining Utility, Income, and Prices: What Will the Consumer Consume?
4.4 4 Combining Utility, Income, and Prices: What Will the Consumer Consume?
(a) Utility Maximization A Good X Good Y U1 BC* U* U2 With one budget constraint, search for indifference curve that maximizes utility Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-45 4.4 4-46 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Tangency is the key to finding the optimal bundle, and occurs where the slope of the indifference curve is equal to the slope of the budget constraint when the marginal rate of substitution is equal to the price ratio Mathematically, 4 Combining Utility, Income, and Prices: What Will the Consumer Consume?
constraint budget of Slope curve ce indifferen of Slope = Y X Y X XY P P MU MU MRS = = Y X Y X P P MU MU = 4.4 4-47 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e What does this imply? Rewriting the tangency condition yields The consumer finds the consumption bundle that provides the most benefit on a cost-adjusted basis Occurs when marginal utility per dollar spent is equalized across all products What does it imply if ? 4 Combining Utility, Income, and Prices: What Will the Consumer Consume?
Y Y X X Y X Y X P MU P MU P P MU MU = = Y Y X X P MU P MU Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-48 figure it out Utility Maximization Sarah gets utility from soda (S ) and hotdogs (H ); her utility function is given by Sarah's income is $12, and the prices of sodas and hotdogs are $2 and $3, respectively What is Sarah's utility-maximizing bundle of sodas and hotdogs? ( ) 5 . 0 5 . 0 5 . 0 5 . 0 5 . 0 5 . 0 5 . 0 ; 5 .
0 = = = H S MU H S MU H S U H S Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-49 figure it out Utility Maximization The tangency condition for maximization is Subbing in the parameters yields So, the ratio of hotdogs to sodas in the optimal bundle should be equal to 2/3, or To find the exact quantities, use the budget constraint H S H S P P MU MU = 3 2 3 2 5 . 0 5 . 0 5 . 0 5 . 0 5 . 0 5 .
0 = = = S H H S H S P P MU MU H S H S S H 3 2 = Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-50 figure it out Utility Maximization The budget constraint is given by Rearranging, Subbing in yields Sarah consumes 3 sodas and 2 hotdogs, and she uses all of her income ($12) S H 3 2 = H S H S + P = P H S 3 2 12 Income + = H S= H P P P = S S H S 5 . 1 6 Income 3 6 2 3 2 5 . 1 6 = = S S S S= 4.4 4-51 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e Implications of Utility Maximization What if two consumers have different preferences? Will they have the same MRS at their optimal bundles? Yes!
Because they face the same ratio of prices! 4 Combining Utility, Income, and Prices: What Will the Consumer Consume? 4.4 Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-52 4 Figure 4.18 The Consumer's Optimal Choice Combining Utility, Income, and Prices: What Will the Consumer Consume?
Gum UM J UJ Budget constraint M iTunes Meg prefers iTunes over gum Jack prefers gum over iTunes 4.5 Conclusion Copyright © 2013 Worth Publishers, All Rights Reserved Microeconomics Goolsbee/Levitt/ Syverson 1/e 4-53 This chapter introduced the underlying mechanisms behind consumer choice Preferences Prices and income In Chapter 5, we make the link between consumer behavior and individual and market demand 4