Household Behavior and
6 Household Behavior and Consumer Choice In chapter four, we consider the various options that are available for organizing a business.The organization of a business is very important as it affects how it operates, how much tax it pays, and how much control the owners have.We will consider the primary forms of business ownership that include sole proprietorship, partnerships, and corporations.In addition, the advantages and disadvantages of each form of organization will be discussed. 4-2 Household Behavior and Consumer Choice
Programs and policies can enhance and support an organizations culture. Household Choice in Output Markets
Every household must make three basic decisions: How much of each product, or output, to demand 2. How much labor to supply 3. How much to spend today and how much to save for the future Programs and policies can enhance and support an organizations culture. The Determinants of Household Demand (as seen in chapter 3)
Factors that influence the quantity of a given good or service demandedby a single household include: The price of the product in question. The income available to the household. The households amount of accumulated wealth. The prices of related products available to the household. The households tastes and preferences. The households expectations about future income, wealth, andprices. Programs and policies can enhance and support an organizations culture. THE BUDGET CONSTRAINT This is the budget constraint when income equals $100 dollars per month, the price of movies is $10 each, and the price of a books is $ 5. If we spent all of our money on books, we could consume at point A. In order to see two movies, which cost a total of $20, you will only have $80 to spend on books, allowing you to buy a maximum of 16 books. This combination is point B. If you were to spend all of your money going to the movies, you could see 10 movies (ispoint C). The combination of these points makes up thebudget constraint. All the points under (and including) the budget constraint are called the opportunity set orchoice set. Programs and policies can enhance and support an organizations culture. choice set or opportunity set
THE BUDGET CONSTRAINT budget constraint The limits imposed on household choices by income, wealth, and product prices. A choice set or opportunity set is the set of options that is defined by a budget constraint. Programs and policies can enhance and support an organizations culture. THE BUDGET CONSTRAINT More Formally
Point E is unattainable given the current income prices. Point D does not exhaust the entire income available. Programs and policies can enhance and support an organizations culture. PXX + PYY = I, THE EQUATION OF THE BUDGET CONSTRAINT
In general, the budget constraint can be written: Where PX = the price of X, X = the quantity of X consumed, PY = the price of Y, Y = the quantity of Y consumed, I = household income. PXX + PYY = I, Programs and policies can enhance and support an organizations culture. THE BASIS OF CHOICE: UTILITY
The satisfaction, or reward, a product yields relative to its alternatives. The basis of choice. a numerical indicator of a persons preferences in which higher levels of utility indicate a greater preference. Programs and policies can enhance and support an organizations culture. THE BASIS OF CHOICE: UTILITY
marginal utility (MU) The additional satisfaction gained by the consumption or use of one more unit of something. total utility The total amount of satisfaction obtained from consumption of a good or service. Marginal utility comes only from the last unit consumed; total utility comes from all units consumed. When marginal utility is zero, total utility stops rising. Programs and policies can enhance and support an organizations culture. Diminishing Marginal Utility and Downward-Sloping Demand
law of diminishing marginal utility The more of any one good consumed in a given period, the less satisfaction (utility) generated by consuming each additional (marginal) unit of the same good. Diminishing marginal utility helps to explain why demand slopes down. Marginal utility falls with each additional unit consumed, so people are not willing to pay as much. Programs and policies can enhance and support an organizations culture. Income and Substitution Effects
Price changes affect households in two ways: The income effect: Consumption changes because purchasing power changes. The substitution effect: Consumption changes because opportunity costs change. Programs and policies can enhance and support an organizations culture. Income and Substitution Effects Of A Price Change (For Normal Goods)
Income effect: When the price of a product falls, a consumer has more purchasing power with the same amount of income. When the price of a product rises, a consumer has less purchasing power with the same amount of income. Substitution effect: When the price of a product falls, that product becomes more attractive relative to potential substitutes. When the price of a product rises, that product becomes less attractive relative to potential substitutes. Programs and policies can enhance and support an organizations culture. Income and Substitution Effects Of A Price Change (For Normal Goods)
Programs and policies can enhance and support an organizations culture. The Diamond/Water Paradox
Water is plentiful. If the price of water was zero, you might argue that water has no value.But it does.Consumers enjoy a huge consumer surplus from water consumption. Household willingness to pay far exceeds the zero price. Programs and policies can enhance and support an organizations culture. The Diamond/Water Paradox
The lesson of the diamond/water paradox is that: the things with the greatest value in use frequently have little or no value in exchange, and the things with the greatest value in exchange frequently have little or no value in use. Programs and policies can enhance and support an organizations culture. Household Choice in Input Markets
As in output markets, households face constrained choices in input markets.They must decide: Whether to work How much to work What kind of a job to work at These decisions are affected by: The availability of jobs Market wage rates The skill possessed by the household Programs and policies can enhance and support an organizations culture. Household Choice in Input Markets
Programs and policies can enhance and support an organizations culture. The wage rate can be thought of as the priceor the opportunity costof the benefits of either unpaid work or leisure. Household Choice in Input Markets
INCOME AND SUBSTITUTION EFFECTS OF A WAGE CHANGE labor supply curve A diagram that shows the quantity of labor supplied at different wage rates.Its shape depends on how households react to changes in the wage rate. Programs and policies can enhance and support an organizations culture. Household Choice in Input Markets
INCOME AND SUBSTITUTION EFFECTS OF A WAGE CHANGE An increase in the wage rate affects households in two ways, known as the substitution and income effects. The substitution effect of a higher wage means that the opportunity cost of leisure is higher.The household will buy less leisure (supply more labor). When the substitution effect outweighs the income effect, the labor supply curve slopes upward. Programs and policies can enhance and support an organizations culture. Household Choice in Input Markets
INCOME AND SUBSTITUTION EFFECTS OF A WAGE CHANGE An increase in the wage rate affects households in two ways, known as the substitution and income effects. The income effect of a higher wage means that households can afford to buy more leisure (offer less labor). When the income effect outweighs the substitution effect, the result is a backward-bending labor supply curve. Programs and policies can enhance and support an organizations culture. REVIEW TERMS AND CONCEPTS
budget constraint choice set or opportunity set consumer surplus diamond/water paradox homogeneous products income effect of a price change labor supply curve law of diminishing marginal utility marginal utility (MU) real income substitution effect of a price change total utility utility Programs and policies can enhance and support an organizations culture.