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Consumer Behavior and Demand Analysis
Consumer Behavior and Demand Analysis
Managerial Economics
Part 3
Consumer Behavior and
Demand Analysis
Fall 2016
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Outline
The Theory of Consumer Behavior
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2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
M PX X PY Y
or
M PX
Y X
PY PY
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Exercise 1
The Budget Constraint
Hurleys income: $1200 per month
Prices: PF = $4 per fish, PM = $1 per mango
A. If Hurley spends all his income on fish,
how many fish does he buy?
B. If Hurley spends all his income on mangos,
how many mangos does he buy?
C. If Hurley buys 100 fish, how many mangos can he
buy?
D. Plot each of the bundles from parts A C on a
graph that measures fish on the horizontal axis and
mangos on the vertical, connect the dots.
2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Hurley must
give up
4 mangos
to get one fish.
Quantity
of Fish
2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Preferences:
What the Consumer Wants
Utility
An abstract measure of the satisfaction or happiness that a
consumer receives from a bundle of goods.
Marginal Utility
The marginal utility of any good is the increase in utility
that the consumer gets from an additional unit of that good.
MU U X
Diminishing marginal utility: For most goods, the more
of the good the consumer already has, the lower the marginal
utility provided by an extra unit of that good.
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Preferences:
What the Consumer Wants
Indifference curve
Also called as equal-utility curve
It shows consumption bundles that give the
consumer the same level of satisfaction
Quantity
of Mangos
One of Hurleys
B indifference curves
A, B, and all other bundles
A on I1 make Hurley equally
happy: he is indifferent
I1
between them.
Quantity of Fish
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Indifference Map
Higher indifference curves are preferred to lower ones.
Quantity of Y
IV
III
II
Quantity of X
1
B
2. Indifference curves are 2
bowed inward (convex). 1 I1
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Quantity
MRS = Negative of of Mangos
the slope of A
indifference curve
MRS = 6
1
B
MRS = 2
1 I1
Quantity of Fish
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Optimization:
What the Consumer Chooses
A is the optimum: The optimum
Quantity
the point on the budget of Mangos is the bundle Hurley
constraint that touches most prefers out of
the highest possible all the bundles he
1200
indifference curve. can afford.
- Hurley prefers B to A,
but he cannot afford B. B
600
A
- Hurley can afford C and D,
but A is on a higher C
indifference curve. D
Optimization:
What the Consumer Chooses
At the optimum, Consumer optimization is
slope of the indifference Quantity another example of
curve equals slope of the of Mangos thinking at the margin.
budget constraint: 1200
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Optimization:
What the Consumer Chooses
At the optimum point A:
Quantity
of Y
MRS = MUX/MUY = PX/PY
MUX/PX = MUY/PY
A
At the optimum, the marginal
utility per dollar spent on good X
equals the marginal utility per dollar
spent on good Y
Quantity
of X
Exercise 2
Utility Maximization
A consumers budget constraint is $20 per day. The prices of
bread and Coke is $2.5 and $2 respectively. Given the
following utility table, What is the consumers best choice?
Number MU of bread MUB/PB MU of Coke MUC /PC
of goods
1 20 8 60 30
2 15 6 40 20
3 12.5 5 20 10
4 10 4 16 8
5 7.5 3 8 4
6 5 2 4 2
Answer: 4 breads, 5 Cokes
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A
$4
A
B
B
$2
DFish
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PF falls to $2 new
optimum
budget constraint 600
rotates outward, 500
Hurley buys
more fish and
fewer mangos.
150 300 600 Quantity
350 of Fish
2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Income effect: B
from B to C,
buy more of both
goods. Quantity
of Fish
2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Indifference curve
Shows bundles of consumption and leisure
that give her the same level of satisfaction.
2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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P From A to B,
P falls 60%, Q rises 300%,
A
$5 ED = 300/(-60) = - 5
B
$2 From B to A,
D P rises 150%, Q falls 75%,
Q ED = (-75)/150 = -0.5
5 20
P
A
$5
B
$2
D In this example,
ED between point A and B = -1.4
Q
5 20
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Exercise 3
The price elasticity of demand for personal
computers is estimated to be 2.2. If the price of
personal computers declines by 20 percent, what
will be the expected percentage increase in the
quantity of computers sold?
= %Q/(20%) = 2.2
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P
A
$5
B In this example,
$2
ED at point A = - 5, ED at point B = - 0.5
D
The slope of a linear demand curve is
Q constant, but its elasticity is not.
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Price Elasticity
(both point price and arc elasticity)
1. The slope of a linear demand
curve is constant, but its
elasticity is not.
2. Points with low price and
high quantity: Inelastic
demand
price
3. Points with high price and
elastic region low quantity: Elastic demand
unit elastic
inelastic region
quantity
Demand
$5
1. A 22% 4
increase
in price
2. leads to a 22%
decrease in quantity
demanded
0 80 100
Quantity
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2. leads to a
67% decrease
Demand
in quantity
demanded
0 50 100 0 90 100
Quantity Quantity
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Price $5 Price $5
Effect A Effect A
4 4 D
D
B
B Quantity
Quantity
Effect
Effect
0 90 100 Q 0 70 100 Q
Slide 47
Another Way
P Elastic
to Remember
Unit Elastic
Linear demand curve A
Inelastic
TR on other curve
Look at arrows to see B
Q
movement in TR
A. Increasing price in the
inelastic region raises
revenue TR
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Marginal Revenue
TR
MR
Q
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Panel A Panel B
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Advertising Elasticity
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Inelastic Elastic
Supply Supply
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$3
Q
100 200
500 525
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Application 1
- New hybrid of
wheat: increase
production per acre
20%
- Supply curve shifts to
the right
- Higher quantity and
lower price
- Demand is inelastic:
total revenue falls
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Application 2
Why did OPEC fail to keep the price of oil high?
- Analysis on the reduction in world market supply for oil
Homework
1. Five consumers have the following marginal utility of apples
and pears. The price of an apple is $1, and the price of a pear
is $2. Which, if any, of these consumers are optimizing over
their choice of fruit? For those who are not, how should they
change their spending?
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Homework
2. Consider a couples decision about how many children to have.
Assume that over a lifetime a couple has 200,000 hours of time to
either work or raise children. The wage is $10 per hour. Raising a
child takes 20,000 hours of time.
a. Draw the budget constraint showing the trade-off between
lifetime consumption and the number of children. (Ignore the fact
that children come only in whole numbers!) Show indifference
curves and an optimum choice.
b. Suppose the wage increases to $12 per hour. Show how the
budget constraint shifts. Using income and substitution effects,
discuss the impact of the change on the number of children and
lifetime consumption.
c. We observe that, as societies get richer and wages rise, people
typically have fewer children. Is this fact consistent with this
model? Explain.
Homework
3. The demand function for bicycles in Holland has been
estimated to be
Q = 2,000 + 15Y 5.5P
where Y is income in thousands of euros, Q is the
quantity demanded in units, and P is the price per unit.
When P = 150 euros and Y = 15(000) euros, determine
the following:
a. Price elasticity of demand
b. Income elasticity of demand
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Homework
4. Two driversTom and Jerryeach drive up to a
gas station. Before looking at the price, each places
an order.
Tom says, Id like 10 gallons of gas.
Jerry says, Id like $10 worth of gas.
What is each drivers price elasticity of demand?
Homework
5. Does drug interdiction increase or decrease drug-related
crime? Explain your answers using supply-and-demand
diagrams.
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