Chapter - 5 Theory of Consumer Behaviour

Managerial Economics
ninth edition
Thoma
Mauric
Chapter 5
Theory of
Consumer Behavior
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics,
Managerial Economics,
Copyright 2008 by the McGraw-Hill Companies, Inc. All
The Consumers Optimization

Problem
Individual consumption decisions

are made with the goal of
maximizing total satisfaction from
consuming various goods and
services
Subject to the constraint that
spending on goods exactly equals the
individuals money income
5-2
Consumer Theory
Assumes buyers are completely
informed about:
Range of products available

Prices of all products
Capacity of products to satisfy
Their income
Requires that consumers can rank all

consumption bundles based on the
level of satisfaction they would receive
from consuming the various bundles
5-3
Typical Consumption Bundles for

Two Goods, X & Y (Figure 5.1)
5-4
Properties of Consumer
Preferences
Completeness
For every pair of consumption bundles, A and

B, the consumer can say one of the following:
A is preferred to B
B is preferred to A
The consumer is indifferent between A and B
Transitivity
If A is preferred to B, and B is preferred to

C, then A must be preferred to C
Nonsatiation
More of a good is always preferred to less
5-5
Utility
Benefits consumers obtain from
goods & services they consume is
utility
A utility function shows an
individuals perception of the utility
level attained from consuming
each conceivable bundle of goods
5-6
Indifference Curves
Locus of points representing
different bundles of goods, each of
which yields the same level of total
utility
Negatively sloped & convex
5-7
Typical Indifference Curve

(Figure 5.2)
5-8
Marginal Rate of Substitution

MRS shows the rate at which one good
can be substituted for another while
keeping utility constant
Negative of the slope of the indifference
curve
Diminishes along the indifference curve as X
increases & Y decreases
Ratio of the marginal utilities of the goods
Y MU X
MRS
X MUY
5-9
Slope of an Indifference Curve &

the MRS (Figure 5.3)
Quantity of good Y
600
T
C (360,320)
320
I
T
B
0
360
Quantity of good X
5-10
800
Indifference Map
Quantity of Y
(Figure 5.4)
IV
III
II
I
Quantity of
X
5-11
Marginal Utility
Addition to total utility attributable
to the addition of one unit of a
good to the current rate of
consumption, holding constant the
amounts of all other goods
consumed
MU U X
5-12
Consumers Budget Line

Shows all possible commodity
bundles that can be purchased at
given prices with a fixed money
income
M PX X PY Y
or
M PX
Y
X
PY PY
5-13
Consumer has a fixed income of

1000$
Price of X = $5, Y = $10
5-14
Consumers Budget Constraint

(Figure 5.5)
5-15
Typical Budget Line
Quantity of Y
M
PY
(Figure 5.6)
M PX
X
PY PY
5-16
Quantity of
X
M
PX
Shifting Budget Lines (Figure 5.7)
100
80
R
A
Quantity of Y
Quantity of Y
120
Z
16
0
20
0
Quantity of X
N
24
0
Panel A Changes in money income
5-17
100
C
12
5
B
20
0
Quantity of X
D
25
0
Panel B Changes in price

of X
Utility Maximization
Utility maximization subject to a
limited money income occurs at the
combination of goods for which the
indifference curve is just tangent to
the budget line
Y MU X PX
MRS
X MUY
PY
5-18
Utility Maximization
Consumer allocates income so that
the marginal utility per dollar spent
on each good is the same for all
commodities purchased
MU X MUY
PX
PY
5-19
Constrained Utility Maximization

(Figure 5.8)
50
Quantity of pizzas
45
40
D
E
IV
30
III
20
15
10
10
20
30
40
50
Quantity of
burgers
5-20
60
70
II
T
I
80
90
100
Individual Consumer Demand

An individuals demand curve for a
specific commodity relates utilitymaximizing quantities purchased to
market prices
Money income & prices held constant
Slope of demand curve illustrates law
of demandquantity demanded varies
inversely with price
5-21
Deriving a Demand Curve

(Figure 5.9)
Quantity of Y
100
Px=$10
Px=$8
Px=$5
Price of X ($)
50 65
90 100
125
200
Quantity of X
10
8
5
Demand for X
0
5-22
50 65
90
Quantity of X
Market Demand & Marginal Benefit

List of prices & quantities consumers are
willing & able to purchase at each price,
all else constant
Derived by horizontally summing
demand curves for all individuals in
market
Because prices along market demand
measure the economic value of each unit
of the good, it can be interpreted as the
marginal benefit curve for a good
5-23
Derivation of Market Demand

(Table 5.1)
Quantity demanded
5-24
Price
Consumer 1
Consumer 2
Consumer 3
Market
demand
$6
12
10
19
12
25
13
10
31
Derivation of Market Demand

Figure (5.10)
5-25
Substitution & Income Effects

When price changes, total change in
quantity demanded is composed of
two parts
Substitution effect
Income effect
5-26

Substitution effect
Change in consumption of a good after a
change in its price, when the consumer
is forced by a change in money income
to consume at some point on the
original indifference curve
Income effect
Change in consumption of a good
resulting strictly from a change in
purchasing power
5-27
Income & Substitution Effects:

A Decrease in Px (Figure 5.12)
Total effect = Substitutio+ Incom
of price
e
n effect
decrease 9 = 5
effect
+4
5-28
Total effect = Substitutio+ Incom

of price
e
n effect
decrease 3 = 5
effect
+ (-2)

Consider the substitution effect
alone:
Amount of good consumed must vary
inversely with price
Income effect reinforces the

substitution effect for a normal
good & offsets it for an inferior good
5-29
Summary of Substitution &

Income Effects (Table 5.2)
Substitution Effect
Income Effect
Normal Good
X rises
X rises
Inferior Good
X rises
X falls
Normal Good
X falls
X falls
Inferior Good
X falls
X rises
Price of X decreases:
Price of X increases:
5-30

Chapter - 5 Theory of Consumer Behaviour

Uploaded by

Copyright:

Available Formats

You might also like

Chapter - 5 Theory of Consumer Behaviour

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter - 5 Theory of Consumer Behaviour

Uploaded by

Copyright:

Available Formats

Managerial Economics

Copyright 2008 by the McGraw-Hill Companies, Inc. All

The Consumers Optimization

Individual consumption decisions

Range of products available

Requires that consumers can rank all

Typical Consumption Bundles for

For every pair of consumption bundles, A and

If A is preferred to B, and B is preferred to

Typical Indifference Curve

Marginal Rate of Substitution

Slope of an Indifference Curve &

Consumers Budget Line

Consumer has a fixed income of

Consumers Budget Constraint

Typical Budget Line

Shifting Budget Lines (Figure 5.7)

Panel A Changes in money income

Panel B Changes in price

Constrained Utility Maximization

Individual Consumer Demand

Deriving a Demand Curve

Market Demand & Marginal Benefit

Derivation of Market Demand

Derivation of Market Demand

Substitution & Income Effects

Substitution & Income Effects

Income & Substitution Effects:

Total effect = Substitutio+ Incom

Substitution & Income Effects

Income effect reinforces the

Summary of Substitution &

You might also like