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Week 06 Consumer Behavior

The document discusses consumer behavior and utility maximization, focusing on the cardinal approach to understanding consumption choices. It uses the example of a model consumer, Lisa, to illustrate how her budget constraints and preferences influence her decisions on purchasing movies and soda. Additionally, it explains the concepts of total and marginal utility, including the principle of diminishing marginal utility.

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Mohammed Kashoob
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14 views18 pages

Week 06 Consumer Behavior

The document discusses consumer behavior and utility maximization, focusing on the cardinal approach to understanding consumption choices. It uses the example of a model consumer, Lisa, to illustrate how her budget constraints and preferences influence her decisions on purchasing movies and soda. Additionally, it explains the concepts of total and marginal utility, including the principle of diminishing marginal utility.

Uploaded by

Mohammed Kashoob
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Department Business Administration

College of Applied Sciences

Week 6

Consumer Behavior and Utility Maximization


(Cardinal Approach)
MICHAEL PARKIN (Microeconomics)
Consumer Choices
The choices that Consumer make as a buyer of goods and services—
Consumer consumption choices—

Consumer Choices are influenced by:


1. Consumption Possibilities
2. Preferences
Consumption Possibilities:
Your consumption possibilities are all the things that you can afford
to buy.
Consumption possibilities can be explain with the help of table and
figure.
• The easiest way to explain consumption possibilities is to consider a
model consumer (Lisa) who buys only two items: movies and soda. If
the total income for Lisa is $40 and the price of Movie is $8 while price
of Soda is $ 4 a case. Find the consumption possibilities for Lisa? We
can find them by using budget equation.
Budget Equation:
We can describe the budget line by using a budget equation. The budget
equation starts with the fact that
Expenditure = Income
Expenditure is equal to the sum of the price of each
good multiplied by the quantity bought.
For Lisa:
Expenditure = (Price of soda) X (Quantity of soda) + (Price of movie)X
(Quantity of movies)
Call the price of soda PS, the quantity of soda QS, the price of a movie PM,
the quantity of movies QM, and income Y. We can now write Lisa’s budget
equation as
PSQS + PMQM = Y
Or, using the prices Lisa faces, $4 a case of soda and $8 a movie, and Lisa’s
income, $40, we get
$4QS + $8QM = $40.
Lisa can choose any quantities of soda (QS) and movies (QM) that satisfy this
equation. To find the relationship between these quantities, divide both
sides of the equation by the price of soda (PS) to get
QS + PM/PS X QM = Y/PS
Now subtract the [(PM/PS) × QM] from both sides of this equation to get:
QS = Y/PS – PM/PS x QM
QS = $40/ $4 - $8 /$4 X QM
Or
QS =10 - 2QM.
To interpret the equation, look at the budget line in Fig. 6.1.
First, set QM equal to zero. The budget equation tells us that QS, the
quantity of soda, is Y/PS, which is 10 cases. This combination of QM and QS
is the one shown in row A of the table 6.1.
Next
Set QS equal to zero then QM equal to 5 (Y\PM). (row F of the table). Check
that you can derive the other rows.
The budget equation contains two variables chosen by the household (QM
and QS) and two variables that the household takes as given (Y/PS and
PM/PS).
Consumer’s Budget Line
Table 6.1
Consumer’s Budget Line
Illustration of Table and Figure 6.1
Table and Figure (6.1) illustrates Lisa’s consumption possibilities of movies and
soda and her budget line.
Rows A through F in the table show six possible ways of allocating $40 to these
two goods.
For example, in row A Lisa buys 10 cases of soda and sees no movies; in row F
she sees 5 movies and buys no soda; and in row C she sees 2 movies and buys 6
cases of soda. Points A through F in the graph illustrate the possibilities
presented in the table, and the line passing through these points is Lisa’s budget
line.
The budget line constrains choices: It marks the boundary between what is
affordable and unaffordable. Lisa can afford all the points on the budget line and
inside it. Points outside the line are unaffordable.
The graph and the table show six possible ways in which Lisa can allocate
$40 to movies and soda. The line AF is Lisa’s budget line( constraint) and
is a boundary between what she can afford and what she cannot afford.
Her choices must lie along the line AF or inside the orange area.
• The slope of the budget constraint measures the rate at which the
consumer can trade one good for the other.
• The slope between two points is calculated as the change in the
vertical distance divided by the change in the horizontal distance. From
point A to point B, the vertical distance is 2 case of Soda, and the
horizontal distance is 1 movie.
• Thus, the slope is 2 case per movie. (Actually, because the budget
constraint slopes downward, the slope is a negative number. But for
our purposes we can ignore the minus sign.)
• Notice that the slope of the budget constraint equals the relative
price of the two goods—the price of one good compared to the
price of the other. A Soda costs 2 times as much as a movie, so
the opportunity cost of a movie is 2 case of Soda
• The budget constraint’s slope of 2 reflects the tradeoff the
market is offering the consumer: 1 movie for 2 case of Soda.

• Preferences: Lisa’s income and the prices that she faces limit her
consumption choices, but she still has lots of choice. The choice
that she makes depends on her preferences—a description of
her likes and dislikes.
Changes in Budget Line due to changes in price
and income
A Change in Prices: When prices change, so does the budget line. The lower
the price of the good measured on the x-axis, other things remaining the
same, the flatter is the budget line.
For example, if the price of a movie falls from $8 to $4, real income in terms of
soda does not change but the relative price of a movie falls. The budget line
rotates outward and becomes flatter, as Fig. 6.2(a) illustrates.
The higher the price of the good measured on the x-axis, other things
remaining the same, the steeper is the budget line.
For example, if the price of a movie rises from $8 to $16, the relative price of a
movie increases. The budget line rotates inward and becomes steeper, as Fig.
6.2(a) illustrates.
The price of a movie
changes.
A fall in the price from
$8 to $4 rotates the
budget line outward
and makes it flatter.
A rise in the price
from $8 to $16 rotates
the budget line inward
and makes it steeper.
A Change in Income: A change in money income changes real income but
does not change the relative price. The budget line shifts, but its slope does
not change.
An increase in money income increases real income and shifts the budget line
rightward.
A decrease in money income decreases real income and shifts the budget line
leftward.
Figure 6.2(b) shows the effect of a change in money income on Lisa’s budget
line. The initial budget line when Lisa’s income is $40 is the same as in Fig.
6.1. The new budget line shows how much Lisa can buy if her income falls to
$20 a month. The two budget lines have the same slope because the relative
price is the same. The new budget line is closer to the origin because Lisa’s
real income has decreased.
Income falls from
$40 to $20 while the
prices of movies and
soda remain the
same.
The budget line shifts
leftward, but its
slope does not
change.
Total and Marginal Utility
Utility: Utility is the benefit or satisfaction that a person gets from the
consumption of goods and services. Utility may measure how much one enjoys
a movie, utility from eating an apple, from living in a certain house, from voting
for a specific candidate, from having a given wireless phone plan.
Total Utility: The total benefit that a person gets from the consumption of all
goods and services is called total utility.
Total utility depends on the level of consumption—more consumption generally
gives more total utility.
Marginal Utility: Define as the change in total utility that results from a one-
unit increase in the quantity of a good consumed.

Total and Marginal Utility is explained with the help of table and figure
Table 6.3
Diminishing Marginal Utility
Table and Figure (6.2) shows that total utility from
soda increases as more soda is consumed (or her total
utility from movies increases as she sees more movies)
but her marginal utility from Soda (or movies)
decreases.
The tendency for marginal utility to decrease as the
consumption of a good increases is so general and
universal that we give it the status of a principle—the
principle of diminishing marginal utility.

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