Ch 4. The Theory of Individual Behavior

1
Ch 4. The Theory of Individual Behavior
2
Consumer Behavior

• Assume 2 goods exist in the economy.
• Assume a consumer is able to order his or her
  preferences for alternative bundles or
  combinations of goods from best to worst.

3
Consumer Behavior

• A gt B
• the consumer prefers bundle A to bundle B.
• A B
• the consumers view the two bundles as equally
  satisfying. He or she indifferent between bundles
  A and B.

4
Consumer Behavior

• The preference ordering is assumed to satisfy
  four basic properties
• 1. Completeness.
• 2. More is better.
• 3. Diminishing marginal rate of
• substitution.
• 4. Transitivity.

5
Consumer Behavior

• Completeness
• - for any two bundles, say A and B,
• either A gt B, B gt A, A B.

6
Consumer Behavior

• More is better
• - for any two bundles, say A and B,
• either A gt B, B gt A, A B.
• Figure 4-1 Page 120.

7
Consumer Behavior

• Diminishing marginal rate of substitution
• - As a consumer obtains more of good
• X, the rate at which he or she is
• willing to substitute good X for good
• Y decreases.

8
Consumer Behavior

• Transitivity
• - For any three bundles, A, B, and C,
• if A gt B and B gt C, then A gt C.
• Similarly A B, and B C, then A - C

9
The Budget Constraint

• Budget set
• The bundles of goods a consumer can
• afford.
• Px X Py Y equals or less M
• The budget set.

10
The Budget Constraint

• Budget line
• The bundles of goods that exhaust a
• consumers income.
• Px X Py Y M
• The budget line.

11
Changes In Income

• Changes in income shrink or expand opportunities.
• Figure 4-5 Page 126.

12
Changes In Prices

• Figure 4-6 Page 127.

13
Consumer Equilibrium

• The objective of the consumer is to choose the
  consumption bundle that maximizes his or her
  utility, or satisfaction.
• Consumer equilibrium
• The affordable bundle that yields the greatest
  satisfaction to the consumer.
• Figure 4-8 Page 128.

14
Consumer Equilibrium

• Consumer equilibrium
• MRS (Px / Py)
• MRS marginal rate of substitution
• Px price of good X
• Py price of good Y

15
Comparative Statics(Price Changes and Consumer
Behavior)

• A change in the price of a good will lead to a
  change in the equilibrium consumption bundle.
• Figure 4-9 Page 130.
• Change in consumer equilibrium due to a
  decrease in the price of good X (Note that good
  Y is a substitute for good X).

16
Comparative Statics(Price Changes and Consumer
Behavior)

• Figure 4-10 Page 131.
• When the price of good X falls, the consumption
  of complementary good Y rises.

17
Comparative Statics(Income Changes and Consumer
Behavior)

• Figure 4-11 Page 132.
• An increase in income increases the consumption
  of normal goods.
• Figure 4-12 Page 133.
• An increase in income decreases the equilibrium
  consumption of good X (an inferior good).

18
Conceptual and Computational Questions

• A consumer has 400 to spend on
• goods X and Y. The market prices of these
  two goods are Px 10 and Py 40.
• 1.a. Illustrate the consumers opportunity
  set in a
• carefully labeled diagram.
• 1.b. Show how the consumers opportunity
  set
• changes if income increases by 400.
  How
• does the 400 increases in income
  alter the
• market rate of substitution between
  goods X
• and Y?

19
Conceptual and Computational Questions

• A consumer must divide 250 between the
  consumption of product X and product Y. The
  relevant market prices are Px5 and Py10.
• 2.a. Write the equation for the consumers
  
• budget line.
• 2.b. Illustrate the consumers opportunity
  set in a
• carefully labeled diagram.
• 2.c. Show how the consumers opportunity
  set
• changes when the price of good X
  increases
• to 10?

20
Conceptual and Computational Questions

• A consumer is in equilibrium at point A in the
  accompanying figure (Figure at page 148). The
  price of good X is 5.
• 3.a. What is the price of good Y?
• 3.b. What is the consumers income?
• 3.c. At point A, how many units of good
  X does
• the consumer purchase?
• 3.d. Suppose the budget line changes so
  that the
• consumer achieves a new
  equilibrium at
• point B. What change in the
  economic
• environment led to this new
  equilibrium? Is
• the consumer better off or worse
  off as a
• result of the price change?