Chapter 4 not to know wether he

or she preffered bundle

The Theory of Individual behavior
CONSUMER BEHAVIOR
Consumer – is an individual who
2. More is Better: If bundleA
purchases goods and services from
firms for thee purpose of
consumption.
Consumer opportunities – represent
the possible goods and services
consumers can afford to consume.
Consumer preferences – determine
which of these goods will be
consumed.
A > B – when the consumer prefers
bundle A than bundle B.
A ~ B – if the consumer views the two
bundles as equally satisfying; will not
care which bundle he or she gets.
B > A – if the cnsumer will choose
bundle B than A.
Four Basic Properties
1. Completeness: For any two
bundles- say A and B – either
A>B, B>A. Or A~B
 If the preferences are
complete, the consumer
is capable of expressing
a preference for, or
indifference among, all
bundles.
 If the preferences were
not complete, the
consumer would claim
A to B, B to A, or was
indiffirent between the
two bundles.
has at least as much of every
good as bundle B and more of
some good, bundle A is
preferred to bundle B.
 If more is better, the
consumer views the
products under
consideration as “goods”
instead of “bads.”
 Indifference curve –
defines the combination
of goods X and Y that
give the consumer the
same level of
satisfaction; the
consumer is indifferent
between any
combination of goods
along the indifference
curve.
 If the bundles lie on the
indifference curve, the
consumer will not care
on which to
consume/buy.
 Marginal Rate of
Substitution – is the
absolute value of the
slope of an indifference
curve; the rate of which
a consumer is willing to
substitute one good for
 the other and still  If the preference is not
maintain the same level ioktransitive, the
of satisfaction; to consumer is unable to
summarize info about a choose the “best” goods
consumer’s preference. to consume.
 Kung ilan yung igigive up
Note: Curves farther from the origin
yun yung MRS.
imply higher levels of satisfaction
than curves closer to the origin.
3. Diminishing Marginal Rate of
Substitution: a consumer CONSTRAINTS
obtains more of good X, the
Constraints in making decisions:
amount of good Y he or she is
willing to give up to obtain 1. Legal constraints
another unit of good X 2. Time constraints
decreases; implies that the 3. Physical constraints
indifference curves are convex 4. Budget constraints
from origin.
 Marginal Utility -
satisfaction I. Budget Constraints – restricts
 Law of diminishing consumer behavior by forcing
marginal utiliy – as a the consumer to select a
consumer consumes bundle of goods that is
more and more stock of affordable.
a commodity, the
M – represents consumer
marginal utility for that
income
commodity decreases/
4. Transitivity: for any three 𝑃𝑥 = Price of X
bundles, A, B and C, if A>B and 𝑃𝑦 = Price of Y
B>C, then A>C. (not C>A kasi
babalik sa unang preference Opportunity set/budget set
kapag C>A) Similarly, if A~B Budget set – combinations of
and B~C, the A~C. goods X and Y that are
 Transitivity and more- affordable for the consumer.
is-better assumption
𝑃𝑥 𝑋 + 𝑃𝑦 𝑌 ≤ 𝑀
implies that
indifference curves do Budget line – when the
not intersect one consumer spends his or her
another. expenditures on good X plus
 his or expenditures on good Y
do not exceed the consumer’s
income; all the combinations of
goods X and Y that exactly
exhaust the consumer’s
income.
If the consumer spent his or her
entire income on good Y:
𝑃𝑦 𝑌 = 𝑀
Maximum affordable quantity of
good Y consumed is:

𝑃𝑥 𝑋 + 𝑃𝑦 𝑌 ≤ 𝑀 𝑀
𝑌=
𝑃𝑦

M = 10

𝑃𝑥 = 1
Budget constaint in slope-intercept
𝑃𝑦 = 2
form
Vertical intercept
𝑃𝑥 𝑀
𝑋+𝑌 = 𝑀 10
𝑃𝑦 𝑃𝑦 = =5
𝑃𝑦 2
Solving for Y
Horizontal intercept
𝑀 𝑃𝑥
𝑌= − 𝑋 𝑀 10
𝑃𝑦 𝑃𝑦 = = 10
𝑃𝑥 1
Vertical intercept
Slope - MRS
𝑀
𝑃𝑥 1
𝑃𝑦 − =−
𝑃𝑦 2
Slope – represents the MRS
Bundle A = 4 units of X; 3 units of Y
𝑃𝑥
− Bundle B = 2 units of X, 4 units of Y
𝑃𝑦
IF B>A = gains 1 unit of Y and gives up
If the consumer spent his or her
2 units of X.
entire income on good X:
4−3 1
𝑃𝑥 𝑋 = 𝑀 Thus, MRS = 2−4 = − 2

Maximum affordable quantity of II. Changes in Income – the

good X consumed is: consumer’s opportunity
𝑀 depends on market prices and
𝑋= the consumer’s income. As
𝑃𝑥
these parameters change, so
Horizontal intercept:
will the consumer’s
𝑀 opportunities.
𝑃𝑥 Suppose,
 𝑀0 = 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑟𝑠 𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 A decrease in the price of good X will
What happens if 𝑀0 increases rotate the budget line
to 𝑀1 while prices remain counterclockwise.
unchanged? Ans: The increase
An increase in the price of good X will
in income will not affect the
rotate the budget line clockwise.
slope of the budget line. But,
as consumer’s income Demonstration Problem:
increases, the horizontal and
M = 100
vertical intercepts of the
budget line both increases. 𝑃𝑥0 = 1
𝑃𝑦 = 5
Relation: consumers income
𝑃𝑥1 = 5
and vertical and horizontal
intercepts of buget line = X intercept of the initial budget line:
directly proportional 𝑀 100
= = 100 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑋
𝑃𝑥 1
𝑴𝟎 increases to 𝑴𝟏 = the
Y intecept of the initial budget line:
budget line shifts to the right
in parallel fashion; increase in 𝑀 100
= = 20 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑌
𝑃𝑦 5
consumer’s opportunity
set/budget set. Slope of initial budget line:
𝑴𝟐 decreases to 𝑴𝟎 = the
𝑃𝑥 1
budget line shifts towards the −
𝑃𝑦
=−
5
origin and the slope of the
budget line remains unchanged. When the𝑃𝑥 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑠 𝑡𝑜 5 (𝑃𝑥1 = 5)
III. Changes in Prices - X intercept of the new budget line:
What happens if the price of good X 𝑀 100
= = 20 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑋
decreases to 𝑃𝑥1 < 𝑃𝑥0 and price of 𝑃𝑥 5
good Y and income remain unchanged?
Y intecept of the new budget line:
Ans: Reduction of the price of good
𝑃
X changes the slope(𝑃𝑥 ), making it No change
𝑦

flatter than before; does not change 𝑀 100

= = 20 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑌
𝑀 𝑃𝑦 5
the Y intercept (𝑃 ) of the budget
𝑦

line; the X intercept is Slope of the new budget line:

𝑀𝑃𝑥1 𝑤ℎ𝑖𝑐ℎ 𝑖𝑠 > 𝑀𝑃𝑥0 . 𝑃𝑥 5
− = − = −1
𝑃𝑦 5
Ultimate effect:
CONSUMER
EQUILIBRIUM
 The objective of a consumer is
to choose the consumption
bundle that maximizes his or
her untility or satisfaction.
 If there was no scarcity, the
more-is-better property would
imply that the consumer would
want to consume bundles that
contained infinite amounts of
goods.
 One implication of scarcity is
the budget line.
Equilibrium – refers to the fact
that the consumer has no
incentive to change to a different
affordable bundle once this point
is reached.
Consumer Equilibrium – the
equilibrium consumption bundle is
the affordable bundle that yields
the greatest satisfaction to the
conumer; where MRS is equal to
the ratio prices.
Important property of consumer
equilbirum:
 At the equilbrium
consumption bundle, the
slope of the indifference
curve is the same as the
slope of budget line.
At a point of consumer equilibrium,
𝑃𝑥
MRS =
𝑃𝑦
 If the indifference curve
slope is steeper than the
slope of budget line, the
consumer is willing to give
up more of good Y to get an
additional unit of good X
than he or she has actually
to give up, based on market
prices.
COMPARATIVE
STATISTICS
PRICE CHANGES AND
CONSUMER BEHAVIOR
A change in price will lead to a change
in equilbirum:
A decrease in the price of good X will
rotate the budget line
counterclockwise.
An increase in the price of good X will
rotate the budget line clockwise.
1. Good X and Y are substitutes
if an increase (decrease) in the
price of C leads to an increase
(decrease) in the consumption
of Y. Substitutes - Price of X
is directly proportional to the
consumption of Y.
2. Good X and Y are complements
if an increase (decrease) in the
price of C leads to an decrease
(increase) in the consumption
of Y. Complements - Price of
X is inversely proportional to
the consumption of Y.
 INCOME CHANGES be worse off after the
price increase.
AND CONSUMER  The increase in the price
BEHAVIOR of good X leads to a budget
line with steeper slope,
If income increases, the budget line
reflecting a higer market
shifts to the right in parallel fashion;
rate of substitution
increase in consumer’s opportunity
between the two goods.
set/budget set.
 An increase in price will
If income decreases, the budget line result to lower indifference
shifts towards the origin and the curve.
slope of the budget line remains  Substitution effect –
unchanged reflects how a consumer
will react to a different
1. Good X is a normal good, if
market rate of
an increase (decrease) in
income leads to an increase substitution.

(decrease) in the
consumption of good X.
APPLICATION OF
Normal good – Income and
consumption of good X is INDIFFERENCE
directly proportional. CURVE ANALYSIS
2. Good X is an inferior good,
if an increase (decrease) in
income leads to an decrease
(increase) in the
CHOICES BY
consumption of good X. CONSUMERS
Inferior good – Income
Buy One, Get One Free
and consumption of good X
is inversely proportional. The buy one, get one deal only
 By calling goods inferior reduces the price of the second unit
doesn’t mean they are of purchased (in fact, it reduces the
poor quality. price of the second good to 0). The
offer does not change the price of
SUBSTITUTION
units below one good and above two
EFFECTS goods.
 Since the budget line is
smaller when price
increases, the consumer will
Cash gifts, In-Kind gifts, and Gift CHOICES BY WORKERS
Certificates
AND MANAGERS
$10 fruitcake – moves to a higher
indifference curve A SIMPLIFIED MODEL
$10 - the budget line will be shifted OF INCOME- LEISURE
out, parallel to the old budget line CHOICE
Cash Gift – is preferred thv an in-
kind gift ofequal value, unless the in-
kind gift is exactly what the Demonstration problem:
consumer would have purchased
Wage: $5/hour + fixed rate of
personally.
$40
Two important benefits to a firm
E = total earnings
that sells gift certificates
L = hours of leisure in a 24-hour
1. As a manager, you can reduce
day
the strain on your refund
department by offering gift E = $40 + $5(24-L)
certificates to customers E = $160 - $5L
looking for gifts. This is true
for normal and inferior goods.
2. If you sell an inferior good, The most worker can earn in a 24-
offering to sell gift hour day is $160 ( no leisure time)
certificates to those looking
The price of a unit of leisure is $5
for gifts may result in a
since the opportunity cost of an
greater quantity sold than if
hour of leisure is one hour of work.
customers resorted to giving
cash gifts.

DECISION OF
MANAGERS
Many managers derive satisfaction
from the underlying output and
profits of their firms. Higher profits
and sales lead to a larger firm, and
larger firms provide more “perks” like
spacious offices, executive health
clubs, corporate jets and the like.
– Willim Baumol When the priceof good X is 𝑃𝑥0 , the
consumer consumes 𝑋 0 units of good
Figure 4-19A pp 123
X; when the price falls to 𝑃𝑥1 , the
A manager who views output and consumption of X increases to 𝑋1 .
profits as “goods” (the Baumol
Figure 4-20B pp 124
hypothesis) has indifference curves
like in figure4-19A This consumer’s demand curve for
good X indicates that, holding other
Figure 4-19B pp 123
things constant, when the price of
The indifference curves are vertical good X is 𝑃0 , the consumer will
lines if the manager does not care purchase 𝑋 0 units of X: when the
about profits; sarisfaction increases proce of good X is 𝑃𝑥1 , the consumer
as the lines move farther to the will purchase 𝑋1 units of X.
right.
MARKET DEMAND
Figure 4-19C pp 123
Market demand curve – is the
The indifference curves are
horizontal summation of individual
horizontal lines if the manager cares
demand curves and indicates the
solely about profits; sarisfaction
total quantity all consumers in the
increases as the lines move farther
market would purchase at each
to the right.
possible price.
THE RELATIONSHIP
BETWEEN
INDIFFERENCE CURVE
ANALYSIS AND
DEMAND CURVES

INDIVIDUAL DEMAND
Figure 4-20A pp 124

The only change that caused the

consumer to move from A to B was a
change in the price of good X: income
and price of good Y were held
constant.