LESSON 4 - THE THEORY OF INDIVIDUAL BEHAVIOR

This tries to explain the underlying principles surrounding the demand for a particular
product or service.

Slide 4-76 Overview

I. Consumer Behavior
A. Indifference Curve Analysis
B. Consumer Preference Ordering
II. Constraints
A. The Budget Constraints
B. Changes in Income
C. Changes in Prices
III. Consumer Equilibrium
IV. Indifference Curve Analysis and Demand Curves
A. Individual Demand
B. Market Demand

Slide 4-77 Consumer Behavior

- With reference to buying products and services is greatly affected by a lot of factors.
- Determined by the opportunities or possibilities available to consumers.
Consumer Opportunities
- Goods and services that consumers can afford to buy or consume.
- Associated with factors such as prices, quantities, taste, preference and other things.
Consumer Preferences
- Would dictate at what price will the consumers actually buy or consume to finally decide
the price and quantity.
- Will dictate how much to buy, what price to accept or buy the product.

Example:
Choice of 2 bundles of goods (number of commodities in one bundle or basket) for a customer

Package A vs Package B
- More will prefer Package A (A is preferred to B)
- More will prefer Package B (A is less than preferred than B)
- Customer is indifferent between the two (A is indifferent to B)

Slide 4-78 Indifference Curve Analysis

Indifference Curve
- A function or curve that defines the combination of two or more goods that give the
consumer the same level of satisfaction.
 (Explanation on Graph)
- A two dimensional diagram showing the
consumption level of commodity y and commodity x.

- The curves represent the indifference curve.

These contain a series of points showing the different
combinations of x and y goods that consumers are
willing to buy from the market at a given price.

- N number of y products or n quantities of x

products. Any points from the curve represent a
certain level of satisfaction.

- A family of indifference curves is termed an

indifference map.

- The farther the indifference curve from the origin. The higher the level of
satisfaction.

- In the graph, highest satisfaction is found in indifference curve 3.

Marginal Rate of Substitution

- Rate at which a consumer is willing to substitute one good for another and
maintain the same satisfaction level.

- In indifference curve 1 (in light blue) any combination of x and y will give a certain level
of satisfaction or Utility level.

- Tell us that as we increase the consumption of x we have to reduce the consumption of

y.
 (Back to graph)
- The amount of commodity y that consumers
are willing to sacrifice in order to have additional
consumption of commodity x.

- As we increase the consumption of

commodity x we have to reduce consumption of
commodity y.

- That contributes to the behavior of

indifference curve which is downward sloping.

Slide 4-79 Consumer Preference Ordering

Properties
- It's important to explain the characteristics of the indifference curves.
- When talking about preferences, you present it through ranking or ordering.
-
Four Basic Properties
1. Completeness
2. More is better
3. Diminishing Marginal Rate of Substitution
4. Transitivity

Slide 4-80 Complete Preferences

1. Completeness
- Means consumers are capable of expressing preferences between all possible bundles.
(I don't know is not an option)
Example: (refer to graph) Bundle A, B, and C

- A and C are found in the same

indifference curve meaning they
represent the same level of
satisfaction and consumers are
indifferent between the two.

- Bundle B is in another indifference

curve, farther from origin and that
represents a higher level of
satisfaction than A and C. B is
preferred to A and C.

- If the customer has to choose, it will

prefer bundle B more.

Slide 4-81 More is Better

2. More is Better
- Syempre gahaman tayo. Human nature. Ahahaha

- Bundles that have at least as much of every good and more of some good are
preferred to other bundles.
 Refer to graph

- B would give us more of commodity x

even in the same level of commodity y b will be
preferred more.

- B is preferred more even if it has the same

level of commodity x with C since it will give
you more of commodity y.

- You'll choose whatever that will give you

more of both commodities or one.

Slide 4-82 Diminishing Marginal Rate of Substitution

3. Diminishing Marginal Rate of Substitution
- Amount of commodity that customers are willing to give up in order to be at the
same level of satisfaction or to have higher consumption of the other commodity.

- The amount a consumer is willing

to sacrifice or to substitute one
product over the other.

(refer to graph)

- As you increase the consumption of

y you have to sacrifice less and less of the
other commodity

- That contributes to the behavior of

the indifference curve being convex to
the origin.

- Initially, you have 100 units of y and

1 unit of x will give you a certain level of
satisfaction (point A)

- Increase consumption of x to 2 units,

you are willing to buy 50 units of y (point B) indifferent from A and so on.
 - There is consistent change in consumption of x. As you increase x the consumers are
willing to sacrifice less and less of the other product.

- Quantity of Y is continuously diminishing as you increase consumption of the other

commodity.

Slide 4-83 Consistent Bundle Offerings

4. Transitivity
- Suggests that no two indifference
curves in one indifference map will
intersect with each other.

- All indifference curves within one

indifference map are more or less
parallel with each other.

Refer to graph
- C is the highest level of satisfaction.

- There will be no point that A will be

preferred more than C.

- It is assumed that there is consistency

and transitivity in the preferences so that
you'll not be caught in long indecision.

Slide 4-84 The Budget Constraints

- We can maximize satisfaction but in most cases availability of funds of consumers must
be considered.

Opportunity Set
- As individual consumers, the quantity of x and y that we can consume depends on the
budget that we have. And can be represented by the budget equation.

(assuming two commodities, price

of y and price of product x, and
assuming that there is
substitutability between products,
meaning you can transfer
expenditure on the x to y. )
 - Equation is read as: price of x times quantity of x plus price of y times quantity of Y
should be equal or less than money.

Refer to graph
- Green shaded area- feasible consumption
region for opportunity Set for the consumer.

- Buy or consume any combination of x and y

within the budget ( is considered affordable for
consumer)

Budget Line
- Equation was changed from inequality to
equality.

- This is a linear budget Line.

- The equation is the red line in the graph.

- We draw the budget Line by simply assuming if you were to consume product y or x how
much quantity can you purchase.

- By manipulating the equation we can come up with if x is zero, px times 0 plus py times
y is equals to M. So it will become y= m/py. That's the coordinate. And if you spend 0 y
and spend all your money to product x. (Ang gulo ni sir alam ko namang nagets niyo na
Yan), basta zero yung coordinate) (x,0), (y,0) para makuha yung line.

- M is the budget or income of a consumer.

- Px/py is the slope of the line, because slope is measured in terms of change in x over
change in y or vice versa. That represents the coefficient of x. If negative, the line is
downward sloping. So the negative coefficient of x is basically the negative slope in the
budget Line.

- It's important to know the slope of the budget Line because it will be used later together
with the indifference curve analysis.

Market Rate of Substitution

- The substitution of product x and product y is represented by the slope of the budget
Line.
 - The amount of x that you are willing to give up in order to buy more of the other product
y.

Slide 4-85 Changes in the Budget Line

Changes in Income effect on Budget

Line
- Income Increases - the coordinates
will change and lead to shift to the
entire budget Line. (Shift to the
right) M1/Py

- Income decreases- (shift to the left)

M2/Py

Changes in Prices
- Prices Increase - rotate clockwise.
Consumers will be able to buy less.

- Prices Decrease - budget Line

rotates counter clockwise, no change
in y, buy if prices of x decreases you'll
be able to buy more, that's why there's
an increase in M0/Px1

Slide 4-86 Consumer Equilibrium

Consumer Equilibrium
- State of consumer where the consumer is maximizing the level of satisfaction within
a given budget constraint or optimization.

- (Optimization)- maximizing something given some limitation, in this case the budget.

- Every consumer wants to maximize satisfaction but we have different levels of income
and have different consumer Equilibrium points.

- Equilibrium consumption bundle is the affordable bundle that yields the highest level
of satisfaction.
 - (Refer to graph) you can determine the
point of consumer Equilibrium when the slope
of the indifference curve is equal to the slope
of the budget Line or the equation (refer to
slide)

- (Back to graph) Budget Line is tangent to

the highest indifference curve ayun yung
equilibrium. (Sana nagegets niyo pa ako. HAHAHA)

- If someone wants to attain the consumer

Equilibrium point, we have to consume a certain
level of x and y.

Slide 4-87 and 88 Price Changes and consumer Equilibrium Point

- In analyzing the effect of price changes to consumer Equilibrium we have to consider the
characteristics of the two products.

Substitute Goods
- Example: coke and Pepsi

- An increase in prices of coke, results in increased demand in Pepsi and vice versa.

Complementary Goods
- DVD player and DVDs

- If prices go up, demand for DVD players will

also decrease.

- Refer to the graph (pretzel and beer) blue

line is the initial budget Line. When the
prices of commodity x falls then the
consumption of y rises. If they are
complementary, that will attract consumers
to consume more beer.

- Budget Line will rotate counterclockwise.

Slide 4-89 and 90 Income Changes and Consumer Equilibrium
- One of the major determinants is income.

Normal Goods
- If income Increases, demand for that good increases too.

Inferior Goods
- If income Increases, demand for that good decreases.

Graph (normal Goods)

- Point B is more preferred than

Point A since it represents a higher
level of satisfaction and would
represent a new consumer Equilibrium
point.

Slide 4-91 Decomposing the Income and Substitution Effects

- Price change has two components: Income
effect and Substitution effect

- Refer to graph because of changes in Price of

a commodity (decrease of x) then the budget
Line rotates counterclockwise. Meaning
consumers can buy more.

- Substitution effect: the movement of

quantity of x consumed from point A to B
within the same indifference curve. As a result
of the decrease in price, consumers tend to
buy more. (Sana kaya niyo pa, malapit na’to matapos)

- Real income in effect increases. It allows

consumers to increase consumption. A new
budget Line is tangent to another indifference curve showing that satisfaction increases
brought about by the decrease in prices of x. Since you were able to buy more. But in
 point C, there's a change in quantity.

- Income effect: Negative. It's not really the income that causes the change in the budget
Line, it's the price change.

- The total price change or net price effect= substitution effect minus income effect.

Slide 4-92 Classic Marketing Application

Buy one Get one Pizza
Refer to graph
- Assuming there is a
substitutability between x
(pizza) and y being other goods.

- Initially you have a budget

Line (Point AB) where the
equilibrium point is at Point C,
where the consumer maximizes
satisfaction given the limited
budget AB. And if you offer a
buy one take one, you'll have
two units of pizza. This explains
why the horizontal portion of the
budget Line exists between D
and E. However, this is not
anymore the relevant budget Line because of the buy one take one policy.

- Beyond the two units a new budget Line will come. Kinked Budget Line (basta ayun
yung ADEF, pagdugtungin niyo na lang). That portion of the level of consumption of two
units because of policy represents a certain level of indifference curve. This will be
tangent to point A.

- Because of the kinked Budget Line, the green indifference curve will be tangent to the
corner (point e) that's the new consumer Equilibrium point.

- It means that implementing buy one take one deal the level of satisfaction of consumers
is higher than before. If you continue to consider the straight blue budget line, then
consumer satisfaction will be lower at the red indifference curve. There will be
inconsistencies in the analysis where when we have the buy one take one deal the
satisfaction decreases. (Syempre ang assumption pag buy one take one tataas yung
level of satisfaction natin) That's why we have kinked budget line to address the
inconsistencies . Looking at the indifference curve it represents a higher level of
satisfaction.
Slide 4-93 Individual Demand Curve
Individual Demand Curve
- Because of changes in prices of commodity x the budget line will continue to rotate
counterclockwise.

- As you decrease the price the

budget line will continuously rotate
counterclockwise.

- With that, the different budget lines

will be tangent to different levels of
indifference curve. The black point
corresponds to the level of
consumption of x0. This also
corresponds to the p0. P0 is initially
the price corresponding to the
quantity, to the level of consumer
Equilibrium point X0.

- If the price decreases, again from

p0 to p1, it will correspond to a
certain level of x1 which is higher
than the X0.

- Joining together the two points the black and blue dot at the second graph will give you
the demand curve. (Quantity of commodity x that consumers are willing to buy at
alternative prices p0 and p1)

- So we can generate a demand curve out of the concept of consumer Equilibrium

points.
Slide 4-93 Market Demand
- Horizontal summation of individual Demand curve.
- If we have three individuals as shown in the graph, one demands one unit and the other
two and so on, the aggregate demand of the market will be the summation of all
individual demands.

Note: Yung iba na nasa ppt ni sir di ko na tinype, ayun lang din naman yung sinasabi niya eh.
Anyways, magrefer pa rin kayo sa slides at book if may hindi klarong concept. Thank you!