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Lectures 3 4 and 5
Lectures 3 4 and 5
Lectures 3 4 and 5
3
Consumer
Behavior
Prepared by:
Fernando & Yvonn Quijano
Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall • Microeconomics • Pindyck/Rubinfeld, 8e.
Framework
Consumers
maximize
their levels
of
satisfaction
Markets
allow
Chapter 3: Consumer Behavior
interaction of
the two and
we obtain an
equilibrium
Producers
maximize
their profits
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Consumer Theory
studying
- Would you want to spend more time on your favourite pastime
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CHAPTER 3 OUTLINE
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Consumer Behavior
1. Consumer preferences
Chapter 3: Consumer Behavior
2. Budget constraints
3. Consumer choices
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3.1 CONSUMER PREFERENCES
Market Baskets
● market basket (or bundle) List with specific quantities
of one or more goods.
A 20 30
B 10 50
Chapter 3: Consumer Behavior
D 40 20
E 30 40
G 10 20
H 10 40
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3.1 CONSUMER PREFERENCES
Ex- I might prefer 4 hrs of studying for OME and 4 hrs of watching
my fav show over 1 hr of studying and 1.5 hr of watching
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3.1 CONSUMER PREFERENCES
immediate discussion.
Ex- (4,3) is preferred to (3,2) is preferred to (1,1)=> (4,3) is preferred to (1,1) hrs
of studying and watching
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3.1 CONSUMER PREFERENCES
Indifference curves
Figure 3.1
clearly preferred to A.
However, A cannot be compared
with B, D, or H without additional
information.
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3.1 CONSUMER PREFERENCES
Indifference curves
Figure 3.2
An Indifference Curve
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3.1 CONSUMER PREFERENCES
Indifference Maps
● indifference map Graph containing a set of indifference curves
showing the market baskets among which a consumer is indifferent.
Figure 3.3
An Indifference Map
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3.1 CONSUMER PREFERENCES
Indifference Maps
Figure 3.4
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3.1 CONSUMER PREFERENCES
goods.
In this figure, the MRS between clothing
(C) and food (F) falls from 6 (between A
and B) to 4 (between B and D) to 2
(between D and E) to 1 (between E and
G).
Convexity The decline in the MRS
reflects a diminishing marginal rate of
substitution. When the MRS
diminishes along an indifference curve,
the curve is convex.
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3.1 CONSUMER PREFERENCES
Ex- 2000 and 10 notes of 200, Amul butter and Britannia butter, fruits
produced by different vendors
● perfect complements Two goods for which the MRS is infinite; the
Chapter 3: Consumer Behavior
Ex- Right and left glove, Mobile phones and sim cards, Wicket and
stumps
Bads
● bad Good for which less is preferred rather than more.
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3.1 CONSUMER PREFERENCES
In (a), Bob views orange juice and In (b), Jane views left shoes and
apple juice as perfect substitutes: right shoes as perfect complements:
He is always indifferent between a An additional left shoe gives her no
glass of one and a glass of the extra satisfaction unless she also
other. obtains the matching right shoe.
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3.1 CONSUMER PREFERENCES
Figure 3.7
Preferences for Automobile Attributes
Owners of Ford Mustang coupes are The opposite is true for owners of
willing to give up considerable interior Ford Explorers. They prefer
space for additional acceleration. interior space to acceleration.
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3.1 CONSUMER PREFERENCES
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3.1 CONSUMER PREFERENCES
Figure 3.9
A cross-country
comparison shows that
individuals living in
countries with higher
GDP per capita are on
average happier than
those living in countries
with lower per-capita
GDP.
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Understanding Consumer preferences better
Videos-
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3.2 BUDGET CONSTRAINTS
A 0 40 $80
B 20 30 $80
D 40 20 $80
E 60 10 $80
G 80 0 $80
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3.2 BUDGET CONSTRAINTS
A Budget Line
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3.2 BUDGET CONSTRAINTS
The Effects of Changes in Income and Prices
Figure 3.11
Effects of a Change in Income on the
Budget Line
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3.2 BUDGET CONSTRAINTS
The Effects of Changes in Income and Prices
Figure 3.12
Effects of a Change in Price on the
Budget Line
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Understanding Budget constraints better
Videos-
https://www.econgraphs.org/graphs/micro/consumer_theory/budget_set/budget
_set_affordability
Chapter 3: Consumer Behavior
Link 2-
https://www.econgraphs.org/graphs/micro/consumer_theory/budget_set/budget
_line_intercepts
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3.3 CONSUMER CHOICE
The maximizing market basket must satisfy two conditions:
1. It must be located on the budget line.
2. It must give the consumer the most preferred combination of
goods and services.
Figure 3.13
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3.3 CONSUMER CHOICE
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3.3 CONSUMER CHOICE
Figure 3.14
Consumer Choice of Automobile Attributes
Chapter 3: Consumer Behavior
The consumers in (a) are willing to trade off a considerable amount of interior space
for some additional acceleration. Given a budget constraint, they will choose a car
that emphasizes acceleration. The opposite is true for consumers in (b).
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3.3 CONSUMER CHOICE
Corner Solutions
● corner solution Situation in which the marginal rate of
substitution for one good in a chosen market basket is not
equal to the slope of the budget line.
Figure 3.15
A Corner Solution
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3.3 CONSUMER CHOICE
Figure 3.16
consumption as well as
education, the student
would be better off at C.
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3* RECAP
Consumers
maximize
their levels
of
satisfaction
Markets
• Maximize allow
Chapter 3: Consumer Behavior
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3.4 REVEALED PREFERENCE
Is there a way to deduce something about the preference from consumer choice?
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3.4 REVEALED PREFERENCE
If a consumer chooses one market basket over another, and if
the chosen market basket is more expensive than the alternative,
then the consumer must prefer the chosen market basket.
Figure 3.17
Revealed Preference:
Two Budget Lines
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3.4 REVEALED PREFERENCE
Figure 3.18
Revealed Preference:
Four Budget Lines
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3.4 REVEALED PREFERENCE
Example-
You have a recreational facility that offers gymnasium and other activities
Situation 1: You pay $100 for all the recreational activities and the price of using the
gym is 4 times the price of other activities
Situation 2: You pay $30 for using the gym and the price of using the gym now is
equal to the price of other activities
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3.4 REVEALED PREFERENCE
Figure 3.19
Initial budget line- $100 for all recreational activities (exercise price/hr=4)
New budget line- Pay a $30 fee for using the gym and exercise price/hr=1
Point A is affordable in both budget sets- 100=4x+y and 70=x+y
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3.5 MARGINAL UTILITY AND CONSUMER CHOICE
Ex- additional satisfaction from the 1st and the 10th portion of favourite dish
Chapter 3: Consumer Behavior
Figure 3.20
Marginal Utility and Happiness
Chapter 3: Consumer Behavior
A comparison of mean levels of satisfaction with life across income classes in the United
States shows that happiness increases with income, but at a diminishing rate.
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* Some practice problems
1. Upon merging with the West German economy, East German consumers indicated a preference for
Mercedes-Benz automobiles over Volkswagens. However, when they converted their savings into
deutsche marks, they flocked to Volkswagen dealerships. How can you explain this apparent
paradox?
2. Draw indifference curves that represent the following individuals’ preferences for hamburgers and
soft drinks. Indicate the direction in which the individuals’ satisfaction (or utility) is increasing.
(a) Jane loves hamburgers and dislikes soft drinks. If she is served a soft drink, she will pour it
down the drain rather than drink it.
Chapter 3: Consumer Behavior
(b) Molly loves hamburgers and soft drinks, but insists on consuming exactly one soft drink for
every two hamburgers that she eats.
(c) Bill likes hamburgers but neither likes nor dislikes soft drinks
3. The price of DVDs (D) is $20 and the price of CDs (C) is $10. Philip has a budget of $100 to spend on
the two goods. Suppose that he has already bought one DVD and one CD. In addition there are 3
more DVDs and 5 more CDs that he would really like to buy.
a) Draw his budget line on a graph with CDs on the horizontal axis.
b) Considering what he has already purchased, and what he still wants to purchase, identify the
three different bundles of CDs and DVDs that he could choose.
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•CHAPTER 4 OUTLINE
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Reconnecting the pattern with the framework
behavior)
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Framework
interaction of
the two and
we obtain an
equilibrium
Producers
maximize
their profits
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•4.1 INDIVIDUAL DEMAND
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•4.1 INDIVIDUAL DEMAND
● price-consumption
curve Curve tracing the utility-
maximizing combinations of two
goods as the price of one
changes.
Chapter 3: Consumer Behavior
● individual demand
curve Curve relating the
quantity of a good that a single
consumer will buy to its price.
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•4.1 INDIVIDUAL DEMAND
Income Changes
• Figure 4.2
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•4.1 INDIVIDUAL DEMAND
• An Inferior Good
and B, becomes an
inferior good when the
income-consumption
curve bends backward
between B and C.
Examples- travel is
normal, fast food is inferior
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•4.1 INDIVIDUAL DEMAND
Engel Curves
• ● Engel curve
Curve relating the quantity of
a good consumed to income.
• Figure 4.4
• An Inferior Good
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•4.1 INDIVIDUAL DEMAND
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•4.1 INDIVIDUAL DEMAND
• Figure 4.5
• An Inferior Good
•Average per-household
expenditures on rented
dwellings, health care,
and entertainment are
plotted as functions of
Chapter 3: Consumer Behavior
annual income.
•Health care and
entertainment are normal
goods, as expenditures
increase with income.
•Rental housing,
however, is an inferior
good for incomes above
$35,000.
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•4.1 INDIVIDUAL DEMAND
PCC
•Recall
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•4.2 INCOME AND SUBSTITUTION EFFECTS
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•4.2 INCOME AND SUBSTITUTION EFFECTS
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•4.2 INCOME AND SUBSTITUTION EFFECTS
Substitution Effect
• Income Effect
● income effect Change in consumption of a good
Chapter 3: Consumer Behavior
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•4.2 INCOME AND SUBSTITUTION EFFECTS
● Total effect
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•4.2 INCOME AND SUBSTITUTION EFFECTS
● Total effect
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•4.2 Giffen goods
May be you are buying 10 potatoes and 2 hamburgers for five days
Now suppose price of potato has increased to $2- cannot substitute with
hamburger- might leave him hungry! He reduces consumption of hamburgers
Chapter 3: Consumer Behavior
Conditions for giffen goods- inferior good, amount spent on it must be a major
share of budget, lack of close substitutes
How different from Veblen goods- type of luxury good that is desired due to
its status symbol-conspicuous consumption
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•4.4 More on giffen goods
•Supplementary material-
https://corporatefinanceinstitute.com/resources/knowledge/ec
onomics/giffen-good/
Chapter 3: Consumer Behavior
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•4.2 INCOME AND SUBSTITUTION EFFECTS
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* Some practice problems
1. Suppose that an individual allocates his or her entire budget between two goods, food and clothing.
Can both goods be inferior? Explain.
3. An individual consumes two goods, clothing and food. Given the information below, illustrate both
the income-consumption curve and the Engel curve for clothing and food.
$10 $2 6 20 $100
$10 $2 8 35 $150
$10 $2 11 45 $200
$10 $2 15 50 $250
4. Judy has decided to allocate exactly $500 to college textbooks every year, even though she knows that
the prices are likely to increase by 5 to 10 percent per year and that she will be getting a substantial
monetary gift from her grandparents next year. What is Judy’s price elasticity of demand for
textbooks? Income elasticity?
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