Consumer Behaviour

© Pilot Publishing Company Ltd. 2005

Indifference Curve


U=10

An indifference curve (IC, )is a line joining all the points (representing different baskets of goods) giving the same utility to an individual.

Good X

Good Y

0

What is an indifference curve?


An indifference map is a set of ICs showing the preference of an individual.

What is an indifference map?

U=10U=20

U=30

Good Y

Good X0

preference


Properties of Indifference Curves of Two Goods


U=10

Good Y

Good X0

+X

-Y

1. ICs of two goods are negatively sloped Keeping utility constant, along an IC,

a basket with more units of good X must have _____ units of good Y.fewer

negative

(Options: more / fewer / positive / negative)

Slope of an IC of two goods (= Δ Y/ Δ X)

must be ________.

If quantities of good X and good Y can be increased or decreased by infinitesimal amounts, the ICs are continuous. Why?

2. Indifference curves are continuous

U=10

Good Y

Good X0

Along U2: point A = point C = U2

Along U1: point A = point B = U1

What is the utility of point A, = U1 or U2?

3. Indifference curves can never intersect

U of the intersection point logical contradiction

A

B

C

U1

U2

U3

Good Y

Good X0

The higher the IC , the higher the utility (U3 > U2 > U1). Why?

The higher the IC , the higher the utility (U3 > U2 > U1). Why?

If a consumer knows his preference on every basket of commodities, the commodity plane will be fully covered by ICs. Why?

4. Full coverage

5. Indifference curves of two goods are convex to the origin

U1

Good Y

Good X0

+1X

-Y

As the consumption of good X rises, MRS (the slope) falls. Why?

convex

As the IC becomes flatter & flatter, its shape is _______ to the origin.

The numerical value of the slope of an IC (+1X -?Y) is equal to the MRS. Why?


Other Shapes of Indifference Curves


Y (A good)

X (A neuter)0

U2

U1

U3

U3>U2>U1

1. X is a neuter and Y is a good

Any increase or decrease in the quantity of X makes no difference to the consumer.

Why?

ICs are ___________.horizontal


ICs are _________ sloping with a/an

_________slope.

2. X is a bad and Y is a good U3>U2>U1

U1

U2

U3

0

Y (A good)

X (A bad)

Why?

upwardincreasing

+X

+Y

To keep U constant, in a bad (+X) requires in a good (+Y) as a compensation.


3. X is a commodity with a satiation threshold (beyond which X turns from a good to a bad)

0

Good Y

X

U1

U2

U3

U3>U2>U1

X becomes a bad X is a good

ICs are __________.

Why?

U-shaped


4. X and Y are perfect substitutes

Good X (pack of 5 kg rice)

Good Y (pack of 8 kg rice)

0 U1 U2 U3

U3>U2>U1

ICs are _________ sloping _______ lines.

Why?

downward

straight


5. X and Y are perfect complements

Good Y (left shoes)

Good X (right shoes)0

ICs are __________.

45o U3>U2>U1

U1

U2

U3

Why?

right-angled


Budget Line


It is also called the budget constraint.

What is a budget line?

Budget line (BL) or consumption possibility curve is a boundary showing the largest possible combinations of goods that a consumer can buy in a market, given his money income and market prices of the goods.


Y

X0

Given I = $100, PX = $20 & PY = $25

The maxi. amount of X one can buy

= ___________$100/$20 = 5

$100/$25 = 4

$20/$25 = 0.8

4

5

+1X

-0.8Y

Derivation of a BL:

To buy 1 more unit of X, one forgoes =____________ unit of Y.

The maxi. amount of Y one can buy

= ___________

The BL is a downward sloping straight line.

The slope of BL = cost of consuming an additional unit of good X in terms of good Y.


Y

X0

A

C

B

Point A: Expenditure ____ Income

Point B: Expenditure ____ Income

Point C: Expenditure ____ Income

Features:

<=>

(Options: > = < )


Equation of budget line

X PX + Y PY = I

Expenditure on good X

Expenditure on good Y

Money income of the consumer


Changes in budget constraints 1. Changes in income

When one’s income increases, the budget line will shift ______ in a parallel manner, and vice versa.

Y

0 X

outward

Why?

in income

in income


Y

0X

2. Proportionate changes in prices

When prices of both goods rise by the same proportion, the budget line will shift _______ in a parallel manner, and vice versa.

inward

Why?

A proportionate in all money prices

A proportionate in all money prices


Y

0X

3. Disproportionate changes in prices

A rise in Px

A fall in Px

tilt inward

tilt outward

When PX , the budget line will _________ and become steeper. Why?

When PX , the budget line will __________ and become _______. Why?

flatter


Consumer Equilibrium


Optimum (最優點 ) or equilibrium (均衡 ) is the best choice of an economic agent in achieving his objective.

What is a consumer equilibrium?

Optimality conditions (最優性條件 ) or equilibrium

conditions (均衡條件 ) are descriptions on thedefining features of the optimum or the equilibrium.


Interior solution When a consumer buys both goods X & Y,

i.e., the equilibrium is not one of the _________ on the budget line, the equilibrium is called

an interior solution (內解點 ).

intercepts


It is the tangency point, the only point on the budget line reaching the highest IC attainable.

U1

U3

Y

X0

U3>U2>U1

X*

Y*

From observation, the best choice achievable is _____________.

Equilibrium: From observation

E*

U2

E* (X*, Y*)

Why?


Equilibrium conditions:

U1

U2

U3

Y

X0

U3>U2>U1

E*

X*

Y*

1. The consumer equilibrium must lie ____ the BL.

2. The consumer equilibrium is the ____________ at which the slope of IC equals the slope of BL.

on

tangency point


Slope of indifference curve Slope of budget line

1. =ΔY/ΔX, holding utility constant

=ΔY/ΔX, holding expenditure or income constant

2. = Marginal rate of substitution in consumption, MRSc

= Marginal rate of substitution in exchange, MRSe

Meaning of the slopes

3. = The maximum amount of Y one is willing to pay for an additional unit of X

= The actual amount of Y one is required to pay for an additional unit of X in exchange

4. = Cost / Value? of an additional unit of X in terms of Y (=MUV)

= Cost / Value? of consuming an additional unit of X in terms of Y (= Px/Py)

Value Cost


Buy X

MRS

c

MRS

eHow is the consumer equilibrium reached?

At point A, MRSc > MRSe (_______ of an additional X > its ________), utility can be raised if the consumer _________ units of X.

U2

U1

Y

X0

A

buys more

(Options: buys more / sells some / value / cost )

valuecost


Sell X

MRS

e

MRSc

U2

U1

Y

X0

At point B, MRSc < MRSe (value < cost), utility can be raised if the consumer _________ units of X.

B

sells some(Options: buys some /

sells some )

How is the consumer equilibrium reached?


U2

U1

Y

X0

MRSc = MRSe (value = cost), utility is maximized & the equilibrium is attained.

E*

How is the consumer equilibrium reached?

Consumer Behaviour

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