Consumer Behavior

How consumer with a limited income decide which G&S to buy?
-Consumer Preferences (dream)
-Budget Constraints (prices)
- Consumer choices (price & preference)

Consumer Preferences
Market Basket – units of specific commodities (bundle)
Food versus Clothing
Market basket Units of Food Units of Clothing
A 20 30
B 10 50
D 40 20
E 30 40
G 10 20
H 10 40
Almaty 2020
#01

3 assumptions of Consumer Preferences
Completeness (equally prefer A to B or B to A)
Transitivity (Prefer A to B, B to C)
More is better than less
Almaty 2020
#02

Indifference Curve
Almaty 2020
#03

Indifference Maps
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#04

Indifference Curves cannot intersect
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#05

The Shape of Indifference Curve
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#06

Marginal Rate of Substitution
MRS is amount of a good that consumer is willing to give up in order to obtain one additional unit of another good
MRS = 3 (means he will give up 3 units of clothes to obtain 1 food)
MRS = “-” delta C/ delta F (MRS IS ALWAYS POSITIVE)
Almaty 2020
#07

4th assumption of Consumer Preferences
Diminishing marginal rate of substitution
Indifference curves are convex
As Food consumption increases,
Additional satisfaction from consumption of Food will decrease
Almaty 2020
#08

Perfect Substitutes & Perfect Complements
Generally, more is preferred to less. But in some cases, things like air pollution preferred less to more.
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#09

Utility
Numerical Score representing the satisfaction that a consumer gets from a given market basket.
Utility Function is the formula that assigns level of satisfaction of the consumer to each market basket.
U (F, C) = F+2C U(F,C)= F*C=2,5*10=25;(D)
If basket A consists of 8F & 3C => U(F,C)=8+2*(3)=14
If basket B consists of 4F & 4C => U(F,C)=4+2*(4)=12
If basket D consists of 4C & 4F => U(F,C)=4+2*(4)=12
He would prefer A than D and B, cause more is better than less
Almaty 2020
#10

Utility Functions & Indifference Curves
U(F,C)= F*C=5*5=25;(A)
=2,5*10=25(D)
=10*2,5=25(B)
Almaty 2020
#11

Ordinal & Cardinal Utility
Ordinal Utility is a function that generates a ranking of market baskets in order of most to least preferred.
Cardinal Utility is a function describing by how much one market basket is preferred to another.
Almaty 2020
#12

Budget Constraints & Budget Line
Constraints that consumers face as a result of limited incomes.
Ex: Women fixed income (I), that could be spent on Food (F) & Clothes (C), Price of C (Pc) & Price of F (Pf).
Budget Line indicates all combinations of F & C for which the total amount of money spent is equal to income.
Almaty 2020
#13

Market Basket & Budget Line
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#14

Market Basket & Budget Line
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#15

The Effects of Changes in Income
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#16

The Effects of Changes in Prices
Almaty 2020
#17

Conclusion for budget line
When the income of consumer changes budget line shifts and slope of the budget line doesn’t change.
When the price of one good changes, budget line rotates inward or outward, and slope of the budget line changes.

Consumer Choice
We assume that
Consumers choose good in rational way & ”to maximize the satisfaction they can achieve, given the limited budget available".
#1 condition: Utility must be located on the budget line
#2 condition: It must give the consumer the most preferred combination of G&S.
Almaty 2020
#18

Maximizing Consumer Satisfaction
Almaty 2020
#19

Maximizing Consumer Satisfaction
MRS = Pf/Pc
Satisfaction is maximized when the marginal rate of substitution (of F for C) is equal to the ratio of the prices (of F to C).
marginal benefit Benefit from the consumption of one additional unit of a good. (MRS, Slope of indifference curve)
marginal cost Cost of one additional unit of a good. (slope of budget line, ratio of prices)
Almaty 2020
#20

Maximizing Consumer Satisfaction
Marginal Benefit = MRS = ½ at point A (slope of indifference curve)
Marginal Cost =Pf/Pc=1/2 at point A (Slope of budget line)
Marginal Cost=Marginal Benefit= Max.Satisfaction
Almaty 2020
#21

Corner Solution
Situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line.
Almaty 2020
#22

Marginal Utility & Consumer Choice
M.U. measures the additional utility obtained from consuming one additional unit of a good.
As consumption increases => Marginal utility will decrease
0=MUf(△F)+MUc(△C)
-(△C/△F)=MUf/MUc
⇩
MRS = MUf/Muc
MRS = Pf/Pc, so => MUf/Pf=MUc/Pc
Almaty 2020
#23

Ideal Cost of Living Indexes
Almaty 2020
#24
Cost of attaining a given level of utility at current prices relative to the cost of attaining the same utility at base-year prices.

Ideal Cost of living adjustment=$1260-$500=$760
Ideal cost of living index=$1260/$500=2,52*100%=252%
2000 100%
2010 252%
252%-100%=152%

Ideal Cost of Living Indexes
Almaty 2020
#25

Laspeyres Index & Paasche Index
Laspeyres price index
Amount of money at current year prices that an individual requires to purchase a bundle of goods and services chosen in a base year divided by the cost of purchasing the same bundle at base-year prices.
Paasche index
money at current-year prices that an individual requires to purchase a current bundle of goods and services divided by the cost of purchasing the same bundle in a base year.
Almaty 2020
#23

Laspeyres Index
$20*15+$2,00*100=$500(2000year)Sarah
$100*15+$2,20*100=1500+220=$1720(2010 years)Rachel
Laspeyres adjustment= $1720-$500=$1220
Laspeyres index= 1720/500=3,44
3,44*100=344%-100%=244%
Consumption is 2000’s consumption
Chain-Weighted Index
Paasche index