KINH TẾ VI MÔ Chapter IV quan nguyen

Theory on consumer’s utility The principle of diminishing marginal utility Consumer’s surplus Consumer’s preferences Budget constraint Utility maximizing choice The Theories on Con

Theory on consumer’s utility

The principle of diminishing marginal utility

Consumer’s surplus

Consumer’s preferences

Budget constraint

Utility maximizing choice

The Theories on Consumer Behavior

1 Utility Theory

1.1 Utility (U)

- The benefit or satisfaction that a person gets

from the consumption of a good or service

1 Utility Theory

1.2 Total utility (TU)

- The total benefit or satisfaction that a person gets from the consumption of goods and services

- Depends on the person’s level of consumption – more consumption generally gives more total utility

I The Theories on Consumer Utility

1 Utility Theory

 If one item is preferred to some alternative, the utility from the item is greater than the alternative

(ordinal, not cardinal, ranking is sufficient)

 Consumers try to obtain the largest possible total

satisfaction (utility) from the market basket that they buy with their incomes.

I The Theories on Consumer Utility

1 Utility Theory

1.3 Marginal utility (MU)

- The change in total utility resulting from a

one-unit increase in the quantity of a good

consumed

U MU

E.g Utility for beer

2 Principle of Diminishing marginal utility:

In a certain time period, continuous

consumption will tend to the increase in total utility but a decrease in marginal utility

=> As more good is consumed, additional

utility consumer gains will be smaller and

smaller

I The Theories on Consumer Utility

Application 1: Diminishing marginal utility and demand curve

 To a consumer, the larger marginal utility, the higher willingness

to pay

 The smaller MU, the lower willingness to pay

The diminishing marginal utility explains the slope downward demand curve

Willingness to Pay:

 The maximum price that a buyer is willing and able to pay for a good.

 Measures how much the buyer values the good or service.

I The Theories on Consumer Utility

Application 2: Diminishing marginal utility and Consumer surplus

consumer will be willing to pay for a good depends upon the expected utility (benefits ) of that good.

 A lower market price will increase consumer surplus

 A higher market price will reduce consumer surplus

I The Theories on Consumer Utility

I The Theories on Consumer Utility

3 2

3 2

I The Theories on Consumer Utility

3 2

I The Theories on Consumer Utility

they might consume into 3 groups: preferred, not

preferred and indifferent

+ Consumers prefer more to less

+ Consumer’s preference is transitivity

II The Theories on Consumer’s choice

Indifference Curves: An Example

Market Basket Units of Food Units of Clothing

The consumer prefers

B

D

Indifference Curves: An Example

 Consumer may decide they are indifference

E H

B

Indifference Curves: An Example

 To describe preferences for all combinations of goods/services, we have a set of indifference

curves – an indifference map

market baskets among which the person is

indifferent.

Indifference Curves

Market basket A

is preferred to B Market basket B is preferred to D.

Indifference Curves - Characteristics

1. Indifference curves slope downward to the

right.

assumption that more is preferred to less.

 Some points that had more of both

goods would be indifferent to a basket with less of both goods

Indifference curves- Characteristics

2 Indifference curves can not cross

 Violates assumption that more is better

3 The shapes of indifference curves describes how a

consumer is willing to substitute one good for

another

 A to B, give up 6 clothing to get 1 food

 D to E, give up 2 clothing to get 1 food

more clothing they will give up to get more food

Indifference curves- Characteristics

1

1

Observation: The amount

of clothing given up for

1 unit of food decreases from 6 to 1

4 6 8 10 12 14 16

Marginal rate of substitution (MRS)

another using the marginal rate of substitution (MRS)

 It quantifies the amount of one good a consumer will give up to obtain more of another good

 It is measured by the slope of the indifference

curve

Marginal Rate of Substitution

MRS    

Marginal Rate of Substitution

 The MRS decreases as we move down the indifference curve

 Along an indifference curve there is a diminishing marginal rate

of substitution.

 The MRS went from 6 to 4 to 1

 If the Utility function is U = g (F, C) then

F C

MU MRS

MU



Marginal Rate of Substitution

different willingness to substitute

 Perfect substitutes

Marginal Rate of Substitution

 Two goods are perfect substitutes when the

marginal rate of substitution of one good for the other is constant

 Example: a person might consider apple juice and orange juice perfect substitutes

of Apple Juice

Consumer Preferences

Orange Juice (glasses)

2 3 4

0

Perfect Substitutes

Consumer Preferences

indifference curves for the goods are shaped as

right angles

 Example: If you have 1 left shoe and 1 right shoe, you are indifferent between having more left shoes only

2 3 4

0

Perfect Complements

2 Budget Constraints

 Budget constraints also limit an individual’s ability to consume in light of the prices they must pay for

various goods and services

Budget Constraints

 The Budget Line

 Indicates all combinations of two commodities for which total money spent equals total income

not consider savings

The Budget Line

the amount of clothing

I C

P F

The Budget Line

 The budget line then can be written:

All income is allocated to food (F) and/or clothing (C)

The Budget Line

calculated that use all income

 These choices can be graphed as the budget line

F

P

P F

C Slope -

2

1- 

Clothing

The Budget Line

Y

X P

P P

I

Y P

X P

I

Y P

X P

I

Y

X Y

Y X

Y X

Budget Constraints

 The vertical intercept (I/PC), illustrates the

maximum amount of C that can be purchased with income I

 The horizontal intercept (I/PF), illustrates the

maximum amount of F that can be purchased with income I

The Budget Line

budget lines

lines and consumer choices

The Budget Line - Changes

 An increase in income causes the budget line to shift outward, parallel to the original line (holding prices constant)

The Budget Line - Changes

 A decrease in income causes the budget line to shift inward, parallel to the original line (holding prices constant)

 Can buy less of both goods with less income

The Budget Line - Changes in Income

A increase in income shifts the budget line outward

Food

Clothing

(units per week)

20 40 60 80

The Budget Line - Changes in Price

(P F = 1)

L 1

An increase in the price of food to

$2.00 changes the slope of the budget line and rotates it inward.

$.50 changes the slope of the budget line and rotates it outward

Clothing (units per week)

80 120 160

40

3 Optimal consumption combination

consumers choose what to buy?

maximize their satisfaction, given the limited budget available to them

Optimal consumption combination

conditions:

combination of goods and services

Optimal consumption combination

a consumer choosing between clothing and food

their budget

Optimal consumption combination

Optimal consumption combination

 Recall, the slope of an indifference curve is:

F

C MRS

Further, the slope of the budget line is:

 Therefore, it can be said at consumer’s optimal consumption point,

 It can be said that satisfaction is maximized when

marginal rate of substitution (of F and C) is equal to the ratio of the prices (of F and C).

point

Optimal consumption combination

A consumer decides to spend his income of 200$ on

X and Y

a P = 4$, P = 2$ Draw this consumer’s budget line

b Due to the decrease in quantity supplied, Y’s price

goes up to 4$ Draw new budget line

c There is a promotion from the seller Buying 20 units

of Y at price of 2$, consumer will get 10 units more free of charge This is applied on the first 20 units of Y only The following units are still applied the price of 2$ (except the bonus) Draw new budget line

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