Post on 24-Feb-2016
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TA Office Hours•Jing “Jill” Yi
Office: 391 AGLSHours: MW 10am – 11amEmail: yijing@neo.tamu.edu
TA Office Hours•Michael Nepveux
Office: 391 AGLSHours: MW 1pm – 3pmEmail: michaelnep2012@aol.com
“The budget should be balanced, the treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.”
-- Cicero , 55 B.C.
Theory of Consumer Behavior
Chapter 3
Topics of DiscussionUtility Theory
Total Utility (Satisfaction)
Marginal Utility
Meet Carl or Carla Consumer
Law of Diminishing Marginal Utility
Indifference Curves
Concept of Isoutility
Marginal Rate of Substitution
The Budget Constraint
Utility Function
A utility function is an algebraic expressionthat allows us to rank consumption bundlesor combinations of goods. Let’s assume that totalutility is given by the product of the quantitiesof goods available to consumers. For the sake of simplicity, let’s also assume only two commoditiesare available to consumers, hamburgers and pizza.
Total utility = Qhamburgers x Qpizza
Pages 39-40
Utility Function
This approach assumes that utility iscardinally measurable in the same sensethat a ruler measures distance. The unit of measurement is utils, a fictitious metric.
We will learn that consumers only need torank alternative combinations of bundles ofgoods.
Pages 39-40
Ranking Total Utility
BundleQuantity of hamburgers
Quantity of pizza
Total Utility
A 2.5 10.0 25B 3.0 7.0 21
C 4.0 6.25 25
Rank A and C over BIndifferent between A and C
Marginal Utility
Marginal utility is the change in utility derived from an increase in consumptionof a particular good.
MUhamburgers = utility ÷ hamburgers
Page 40
Marginal Utility
Marginal utility is the change in utility derived from an increase in consumptionof a particular good.
MUhamburgers = utility ÷ hamburgers
This value will fall (rise) as consumptionincreases (decreases).
Page 40
Marginal utility goesto zero at the peak ofthe total utility curve
Page 42
“Law of Diminishing Marginal Utility” --
Marginal utility decreases as more of a good is consumed over a given time period.
Indifference Curves
Cardinal measurement of utility is bothunreasonable and unnecessary. We caninstead use an ordinal measurement of utility,which means all we need to know is that onebundle is preferred over another.
Page 43
Indifference CurvesCardinal measurement of utility is bothunreasonable and unnecessary. We caninstead use an ordinal measurement of utility,which means all we need to know is that onebundle is preferred over another.
Modern consumption theory is based upon the notion of isoutility curves, where “iso” isthe Greek for “equal”. The consumer isassumed to be indifferent among differentcombinations of goods along a isoutility curve.
Page 43
Page 43
Increasingutility
Page 43
The two indifferencecurves here can be thought of as providing 200 and 700 utils of utility.
Page 43
One would normally expect a number of additional isoutilityor indifference curves.
The two indifferencecurves here can be thought of as providing 200 and 700 utils of utility.
Slope of Indifference Curve
The slope of an indifference curve is knownas the marginal rate of substitution (MRS).The marginal rate of substitution of hamburgersfor tacos is given by:
MRS = tacos ÷ hamburgers
Page 43
Slope of Indifference Curve
The slope of an indifference curve is knownas the marginal rate of substitution (MRS).The marginal rate of substitution of hamburgersfor tacos is given by:
MRS = tacos ÷ hamburgersThe MRS reflects the number of tacos a consumeris willing to give up for an additional hamburger.
Pages 43-44
Page 43
The MRS between points M and Q is equal to: -2.0 = -2 ÷ 1.0
Page 43
This means the consumer is will to give up 2 tacos in exchange for an additional hamburger!
IMPORTANT POINT• Along the SAME indifference curve, the decrease
in taco consumption from point M to point Q times the accompanying increase in the MU of tacos MUST be identical to the increase in consumption of hamburgers from point M to point Q times the accompanying decrease in the MU of hamburgers.
Δtacos MUhamburgers
Δhamburgers MUtacos=
(3.4)
Concept of Budget Constraint
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS BUDGETWeekly budget for fast food:
Page 45
where PHAMBURGERS and PTACOS represent the current price of hamburgers and tacos while QHAMBURGERS and QTACOS represent the quantities you plan to consume during the week.
Concept of Budget Constraint
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS BUDGETWeekly budget for fast food:
Slope of budget line = - (PHAMBURGERS ÷ PTACOS)Page 45
where PHAMBURGERS and PTACOS represent the current price of hamburgers and tacos while QHAMBURGERS and QTACOS repre- sent the quantities you plan to consume during the week.
The budget constraint limits the amount that you can be spent on these items. A graph depicting this constraint is referred to as the budget line. The slope of this line is given by:
Example of a Budget Constraint
Tacos($0.50 each)
Hamburgers($1.25 each) Expenditure
10 0 $5.005 2 $5.000 4 $5.00
Each of these combinationsrepresent a point on thebudget line…. Page 46
Original budget line Change in income or both prices
Change in taco price Change in hamburger price
Page 46
Line BA is the original budget line. It says that Carl can afford either 10 tacos or two hamburgers a week with his $5 weekly budget.
Original budget line Change in income or both prices
Change in taco price Change in hamburger price
Page 46
The original budget linewould shift in to line FGif Carl’s available incomefell in half (or both pricesdoubled). It would shift out to line ED if Carl’s income doubled (or bothprices fell in half).
Original budget line Change in income or both prices
Change in taco price Change in hamburger price
Page 46
The budget line would shiftout to line AE if the price oftacos fell in half or shift into line AF if taco prices fellin half. Note the price ofhamburgers did not change!
Original budget line Change in income or both prices
Change in taco price Change in hamburger price
Page 46
Finally, the budget line wouldshift out to line BD if the priceof hamburgers fell in half, orin to line line BG if the priceof hamburgers doubled.
Engel’s Law:
The more wealthy a consumer becomes, the percentage of income spent for food decreases.
1857
Chapter 4 unites the conceptsof indifference curves with abudget constraint to determine consumer equilibrium….
GIG’EM AGGIES!!
BTHO ALABAMA!!