23735829 theory of consumer behavior

8/8/2019 23735829 Theory of Consumer Behavior

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The McGraw-Hill Series

anagerialEconomics ThomasMauriceeighth edition

Chapter 5

Theory of

Consumer Behavior


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ManagerialEconomics2

The McGraw-Hill Series2

Utility

Benefits consumers obtain from

goods & services they consume is

utility

A utility function shows an

individuals perception of the utility

level attained from consumingeach conceivable bundle of goods


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Theory of Consumer Behavior

Assume consumers have complete

information about availability, prices, &

utility levels of all goods & services

All bundles of goods can be ranked

based on their ability to provide utility

for any pair of bundlesA & B:

Prefer bundle A to bundle B Prefer bundle Bto bundle A

Indifferent between the two bundles


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Indifference Curves

Locus of points representing different

bundles of goods, each of which yields

the same level of total utility

Negatively sloped & convex

Marginal rate of substitution (MRS)

Absolute value of the slope of the

indifference curve Diminishes along the indifference curve as X

increases & Ydecreases


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Typical Indifference Curve(Figure 5.1)


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Indifference Map (Figure 5.3)

QuantityofY

Quantity ofX

I

II

III

IV


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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 =

i l i


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Marginal Rate of Substitution

MRSshows the rate at which one

good can be substituted for another

while keeping utility constant

Negative of the slope of theindifference curve

Ratio of the marginal utilities of thegoods

X

Y

MUYMRS

X MU

=

M i l E i


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Consumers Budget Line

Shows all possible commodity

bundles that can be purchased at

given prices with a fixed money

income

X YM P X P Y = +

X

Y Y

PMY X

P P=

or

X YM P X P Y = +

X

Y Y

PMY X

P P=

or

M i l E i


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Typical Budget Line (Figure 5.5)

Quantit

yofY

Quantity of

X

A

B

Y

M

P

X

M

P

= X

Y Y

PMY X

P P

M i l E i


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Panel B Changes in priceofX

200

100A

B

250

D

R

N

120

240

Shifting Budget Lines (Figure 5.6)

Quantit

yofY

Quantity of X

Panel A Changes in moneyincome

Quantit

yofY

Quantity of X

A

B

100

F

Z

80

160

200

125

C

M i l E i


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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

X X

Y Y

MU P YMRS

X MU P

= = =

M i l E i


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Utility Maximization

Consumer allocates income so that

the marginal utility per dollar spent

on each good is the same for all

commodities purchased

X Y

X Y

MU MU

P P=

M i l E i


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A

I

C

B

II

R

T

Constrained Utility Maximization

(Figure 5.7)

Quantity of

burgers

Qua

ntityofpizzas

0 8020 10040 60

10

20

30

40

50

7010 9030 50

E

III

D

IV

45

15

Managerial Economics


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Individual Consumer Demand

An individuals demand curve for a

specific commodity relates utility-

maximizing quantities purchased to

market prices

Money income & prices held constant

Slope of demand curve illustrates lawof demandquantity demanded variesinversely with price



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Market Demand

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



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Derivation of Market Demand(Table 5.1)

Quantity demanded

Price Consumer 1 Consumer 2 Consumer 3 Marketdemand

$6

2

1

5

4

3

3

12

13

5

8

10

0

7

10

1

3

5

0

6

8

0

1

4

3

25

31

6

12

19



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Derivation of Market DemandFigure (5.9)



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Substitution & Income Effects

When price changes, total change in

quantity demanded is composed of

two parts

Substitution effect

Income effect

Managerial Economics20


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Substitution effect

Change in consumption of a good after achange in its price, when the consumer

is forced by a change in money incometo consume at some point on theoriginal indifference curve

Income effect

Change in consumption of a goodresulting strictly from a change inpurchasing power



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Income & Substitution Effects:A Decrease in Px (Figure 5.11)

Total effectof pricedecrease

= Substitution effect

+ Incomeeffect 9= 5 + 4

Total effectof pricedecrease

= Substitution effect

+ Incomeeffect3= 5 + (-2)



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Th M G Hill S i22


Consider the substitution effect

alone:

Amount of good consumed must varyinversely with price

Income effect reinforces the

substitution effect for a normal

good & offsets it for an inferior good

23735829 theory of consumer behavior

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