econ 201 lecture 4.1 consumer demand. copyright © 2006 pearson addison-wesley. all rights reserved....
TRANSCRIPT
Econ 201 Lecture 4.1Consumer Demand
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Budget Line
• We represent the consumption opportunities available to the consumer with a budget line. Shows the combinations of goods and
services consumers are able to consume, given income and prices
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Figure 7.1 The Budget Line
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Budget Line Characteristics
• Each point on the budget line represents consumption bundles of goods that can be purchased at current prices with a given amount of income.
• The budget line is a straight line with a negative slope: Slope of the budget line = Represents the trade-offs between
the goods
Px Py
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Budget Line Characteristics (cont’d)
• The intercepts of the budget line represent the maximum amounts of the goods that the consumer can buy. Found by dividing income by the price of
each good
• Consumption bundles outside the budget line cannot be purchased with the given income.
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Figure 7.2(a) The Effect of Changes in Income and Price on the Budget Line
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Figure 7.2(b) The Effect of Changes in Income and Price on the Budget Line
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Assumptions about Consumer Behavior
• Consumers maximize their well-being, not their income. Doesn’t rule out altruism
Economists use the term utility to refer to the benefits consumers receive from consuming goods and services.
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Assumptions about Consumer Behavior (cont’d)
• Consumers are rational. They behave in a consistent manner.
• Consumers have perfect foresight about the satisfaction they will receive from a good or service.
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Marginal Utility
• Consumers make decisions based on the additional benefit from consuming one more unit of a good or service. Marginal Utility (MU)—the change in
total utility that results from a one unit change in consumption.
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Maximizing Utility
• Consumers’ objective is to maximize their utility, given the fact that their income is limited.
• Consumers do this by comparing the marginal utility of one good to the amount of another good they must give up to get it.
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Marginal Utility per Dollar
• The first step in analyzing consumer behavior is to calculate the marginal utility a consumer receives from each dollar spent on a good or service. For example:
per Dollar of PizzaMarginal Utility Marginal Utility of Pizza
Price of Pizza
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Utility Maximization
• Consumers maximize their utility by allocating their income to the good that yields the highest MU per dollar.
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Utility Maximization (cont’d)
• For example, suppose a consumer purchased two goods, CDs and Pizza:
If MUcd / Pcd > MUpizza / Ppizza then the consumer should buy more CDs.
If MUpizza / Ppizza > MUcd / Pcd then the consumer should buy more pizzas.
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The Equimarginal Principle
• Thus, utility is maximized when the marginal utility per dollar is equal across all goods. The consumer is in equilibrium.
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Utility Maximization and Individual Demand
• Downward-sloping individual demand curves result from consumers maximizing their utility subject to their budget constraint.
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Income and Substitution Effects
• A change in the price of a good leads to two effects: The substitution effect—consumers
will purchase more a good that has become relatively cheaper.
The income effect—a change in the price of a good changes a consumer’s purchasing power.
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Income and Substitution Effects (cont’d)
• For normal goods, the income effect reinforces the substitution effect.
• For inferior goods, the income effect partially offsets the substitution effect.
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Summary
• All consumers make decisions by allocating their limited income over the goods and services they would like to consume.
• Consumers maximize utility, are rational, and have perfect foresight.
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Summary (cont’d)
• Consumers will allocate their income such that marginal utility per dollar spent is equal across goods.
• Other things remaining constant, consumers will alter their purchases of a good when the price of that good changes. Individual demand is the result of
utility maximization.