Chapter 7 - Consumer behavior. In this chapter you will learn: How revealed preferences relate to utility, how budget constraints affect utility maximization, how income affects consumption choices, how prices affect consumption choices and how to distinguish between income and substitution effects.
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Chapter 7
Consumer Behavior
What will you learn in this chapter?
• How revealed preferences relate to utility
• How budget constraints affect utility
maximization
• How income affects consumption choices
• How prices affect consumption choices and how
to distinguish between income and substitution
effects
• How utility is influenced by outside perceptions,
and how people get utility from altruism and
reciprocity
satisfaction a person derives from something
–Incorporates emotions and sensations
–Universal measure (or yardstick) that allows
individuals to compare choices
–Not typically comparable across individuals
making choices
–For example, if playing soccer for the next hour
yields more utility than playing baseball, rational
individuals will play soccer
Ut il ity basics
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the utility people experience?
–Observe what people actually do
people’s preferences can be determined by
observing their choices and behavior
person at one date
Revealed preferences
• The principle of revealed preferences isn’t feasible
for analyzing how people make choices
• Instead, a more formal method is required
• Utility functions aid in systematically analyzing
choices
–A utility function isa formula for calculating the total
utility that a particular person derives from consuming
a combination of goods and services
services that a person could choose to consume
Utility functions
absolute
of 3 for each serving of mac‐n‐cheese she eats,
2 for broccoli, and 8 for ice cream
servings of broccoli, and 2 of ice cream, then:
Utility functions
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• When individuals continue to engage in an activity
or consume more of one good or service, the
utility from the next unit is not as great as the last
unit
–Marginal utilityis the change in total utility from
consuming an additional unit of a good or service
–The principle of diminishing marginal utilityis that the
additional utility gained from consuming successive
units of a good or service tends to be smaller than the
utility gained from the previous unit or service
• Sometimes, marginal utility becomes negative
Marginal utility
Diminishing marginal utility
Scoops of ice cream
-1 0 1 2 3 4 5 6 7
1 2 3 4 5 6 7 8
Marginal utility per scoop
A
Scoops of ice cream
8 0
5
10
15
20
25
1 2 3 4 5 6 7
Total utility
A
The utility function and the marginal utility can be plotted. An individual
maximizes utility when total utility is greatest or marginal utility is zero.
Marginal utility measures the per unit utility from each scoop of ice
cream.
Total utility increases with each scoop of
ice cream until point A, the seventh
scoop, at which total utility is maximized.
by the time and money available to them
those constraints by spending their resources
total utility
combinations of goods and services a
consumer can buy for a given income
Maximizing utility with constraints
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The budget constraint
1
2
3
4
5
6
7
8
9
Movie tickets
Concert tickets
A
C
B
Cody can buy 8 movie
tickets for $120 …
…or 4 movie tickets and
2 concert tickets …
…or 4 concert tickets.
The budget constraint for two goods is displayed using a movie ticket
price of $15, a concert ticket price of $30, and an income of $120.
• Point A: All income spent on movies (8 movie tickets)
• Point B: Income spent
on both goods (4 movie and 2 concert tickets)
• Point C: All income spent on concerts (4 concert tickets)
• Represents all feasible bundles
Active Learning: The budget constraint
1
2
3
4
5
6
7
8
9
Movie tickets
Concert tickets
A
C
B
H
I
F
G
D
J
E
K
Which bundle(s) are not within the following budget constraint?
Active Learning: The budget constraint
• Find all feasible bundles using a movie ticket price of $15, a
concert ticket price of $30, and an income of $120.
• Is the bundle of 4 concert tickets and 1 movie ticket feasible?
Bundle Concerttickets Movie Totalcost
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Maximizing total utility
Utility from movie tickets
Number of
tickets Marginal utility Total utility
Utility from concert tickets
Number of tickets Marginal utility Total utility
95
95
95
80
65
35
10
‐10
110 85 25 0
Below are the associated utilities from consuming a specific
number of concerts and movie tickets.
Utility increases with each concert ticket until 3 tickets , at which total utility is maximized.
Utility increases with each movie ticket
until 7 tickets , at which total utility is
maximized.
Maximizing total utility
Bundle Concerttickets Moviemovie ticketsUtility from utilityTotal
0
100
185 210
465
465
365 190
0
465
565
400
210
Utility from concert tickets
550
To maximize total utility, the total utility of each feasible bundle is
identified and then compared to each other.
• Bundle C with 2 concert tickets and 4 movie tickets has the highest total
utility and is the preferred bundle.
• Given this budget, a rational consumer spends all income on the
combination of movie and concert tickets that maximizes utility.
Maximizing total utility
1
2
3
4
5
6
7
8
9
Concert tickets
A
Budget constraint
At point A, utility from
concert tickets is 0 and
utility from movie tickets is
465 Total utility is 465.
B
C
D
E
At point B, utility from
concert tickets is 100 and
utility from movie tickets is
465 Total utility is 565.
At point D, utility from concert tickets is 210 and utility from movie tickets is
190 Total utility is 400.
At point C, utility from concert tickets is 185 and utility from movie tickets is
365 Total utility is 550.
At point E, utility from concert tickets is 210 and utility from movie tickets is
0 Total utility is 210.
Movie tickets
Each bundle on the budget constraint has a corresponding utility.
• Utility falls as one moves away from the preferred bundle, C.
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bundles of goods and services become
affordable
affordable, and consumers will probably have
to cut consumption of some things
the entire budget line outward
Responding to changes in income
The effect of an increase in income
• An increase in income allows individuals to afford more goods.
• The entire budget line shifts outward.
2
4
6
8
10
12
14
Movie tickets
Concert tickets
1 An increase in
income shifts the
budget curve out.
New budget constraint
2 Cody can now afford as many as 12 movie tickets
or 6 concert tickets.
Suppose a person’s income increases from $120 to $180.
Active Learning: Effect of a decrease in
income
Suppose a mother decides to reduce her child’s movie and concert
allowance. Graphically demonstrate the effect.
2
4
6
8
10
12
14
Movie tickets
Concert tickets
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Active Learning: Effect of a decrease in
income
Suppose a mother decides to reduce her child’s movie and concert
allowance. Graphically demonstrate the effect.
2
4
6
8
10
12
14
Movie tickets
Concert tickets
1 A decrease in income shifts the budget curve in.
New budget constraint
• When prices change, an individual’s budget
constraint is affected in two ways:
–An income effectoccurs as consumption changes from
increased effective wealth due to a lower price
–The substitution effectis the change in consumption
that results from a change in the relative price of
goods
• The opportunity cost of consuming a good changes as prices
change.
• A price change causes the budget line to rotate
Responding to changes in prices
The effect of a price change
• When the price of one good changes, the budget constraint rotates outward.
• The new budget line demonstrates the new feasible bundles that are now available.
• The change in the slope
of the budget line reflects the change in the relative prices of the two goods.
2
4
6
8
10
12
14
Movie tickets
A change in the price
of one good rotates
the budget curve.
12 movie tickets
are now
affordable.
New budget constraint
Suppose the price of a movie ticket decreases from $15 to $10.
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Active Learning: The effect of a price change
• Suppose that the price of a movie ticket increases from
$15 to $30, while the price of a concert ticket and the
consumer’s income stay the same at $30 and $120
respectively
• Find all feasible bundles of movie tickets and concert
tickets
Bundle Concerttickets Movie Totalcost
–Outside perception:
• What others think of your purchases.
• How much others have.
–Inward preferences:
• How you prefer to spend your money.
preferences contribute to decision making
Utility and society
• Utility maximization encompasses individuals
giving to others
–Altruismis a motive for action in which a person’s
utility increases simply because someone else’s utility
increases
–Altruistic and selfish or image‐conscious motivations
can coexist perfectly well
• Utility maximization suggests people gain utility by
punishing bad behavior and rewarding good
behavior
–Reciprocityis responding to another’s action with a
similar action
Utility, altruism, and reciprocity
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Summary
• Economists assume that individuals seek to
maximizes their utility within the limits of their
available resources
• Individuals are constrained by their income and
the prices of goods they desire to purchase
• A budget constraint shows all possible feasible
consumption bundles available to an individual
given a fixed budget
–An increase in income shifts the budget constraint
outward
–An increase in price causes the budget constraint to
rotate inward
Summary
• Economists generally assume that individuals’
preferences are demonstrated through the
choices that they make, a concept known as
revealed preference
• Individuals gain utility from a variety of sources
–Outside perception
–Inward preferences
• Utility maximization:
–Individuals giving to others
–People gain utility by punishing bad behavior and
rewarding good behavior