Transcript Hastings6-ConsumerBe..

Introduction to Agricultural and
Natural Resources
Consumer Behavior and
Market Demand
FREC 150
Dr. Steven E. Hastings
Consumer Behavior and Market
Demand
• This Outline Cover Chapter 3, 4 and 5 in Penson et al.
• Major Topics
– The Concept of Utility
– Model of Consumer Choice
• Important Concepts – Budget Line, Indifference Curve and Maximizing Utility
– Individual Demand Curve
– Market Demand
• Important Terminology
• Factors that Shift
– Engel Curve
– Price and Income Elasticity
The Concept of Utility
• The Concept of Utility
– Utility is “satisfaction” from consuming or using a
good or service (or a bundle of good and services).
– Utility varies by consumer or user.
– As more of a good is consumed,
• Total Utility increases
• Marginal Utility ( Total Utility /
1 Unit Consumed)
– See Table 3-2 and in the text; plot the data!
– Illustrates the “law of diminishing marginal utility”.
Total and Marginal Utility
TU – increases at
A decreasing rate
MU – change in TU /
change in hamburgers
MU - decreases
Figure 3–1a Total utility continues to increase as the number of hamburgers consumed increases, at least up
to 11 hamburgers. At this point, total utility is maximized. Beyond 11 hamburgers, total utility decreases (A).
Marginal utility declines as Sue increases her consumption of hamburgers (B).
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Figure 3–1b Total utility continues to increase as the number of hamburgers consumed increases, at least up
to 11 hamburgers. At this point, total utility is maximized. Beyond 11 hamburgers, total utility decreases (A).
Marginal utility declines as Sue increases her consumption of hamburgers (B).
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Marginal utility goes to zero at the peak of the total utility curve
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
• Consumer Choice
– The basic problem is how to allocate a fixed,
limited budget among various goods and services
to maximize ones’ utility.
– Economists use a “model” of consumer theory.
– Assumptions: 1) people are rational, 2) people can
“rank” goods and services, and 3) income
(budgets) are limited.
Consumer Behavior and Demand
• Concepts of Consumer Theory
– Indifference Curve(s) – all combinations of two goods that provide the
same level of satisfaction. Each curve is a different level of satisfaction
(utility).
– A Budget Line (Constraint) – a line connecting all combinations of two goods
that the consumer can buy with a fixed budget. Prices of goods are fixed,
initially.
The two indifference curves here can be thought of as providing 200
and 700 utils of utility.
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
One would normally expect a number of additional isoutility or
indifference curves.
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Which bundle would you prefer more…bundle M or bundle Q?
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
The answer is that this we would be indifferent because they give us
the same utility. The ultimate choice will depend on the prices of
these two products.
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
What about the choice between bundle M and bundle P?
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
We would prefer bundle P over bundle M because it gives us more
utility or satisfaction. The question is whether we can afford to buy 5
tacos and 5 hamburgers!
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Example of a Budget Constraint
Table 3–3
Example of a Budget Constraint
Each of these combinations represent a point on the budget line…
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Indifference Curves
Characteristics of “nomal shaped” IC’s:
convex to the origin, do not cross, and require only “ranking”
Line BA is the original budget line. It says that Carl can afford either
10 tacos or two hamburgers a week with his $5 weekly budget.
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
The original budget line would shift in to line FG if Carl’s available
income fell in half (or both prices doubled). It would shift out to line
ED if Carl’s income doubled (or both prices fell in half).
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
The budget line would shift out to line AE if the price of tacos fell in
half or shift in to line AF if taco prices fell in half. Note the price of
hamburgers did not change!
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Finally, the budget line would shift out to line BD if the price of
hamburgers fell in half, or in to line line BG if the price of
hamburgers doubled.
Introduction to Agricultural Economics, 6e
Penson | Capps | Rosson | Woodward
Copyright © 2015, 2010 by Pearson Education, Inc.
All Rights Reserved
Budget Constraint (Line)
Maximizing Utility
• Assume a consumer is rational and want to get the greatest
satisfaction possible from his/her budget.
• Combine a set of indifference curves and a budget.
• Utility is maximized at the combination of goods where the budget
line is tangent to the highest (farthest to the right) indifference
curve.
• Mathematically speaking, the slope of the budget line is equal to
the slope of the indifference curve.
• Referred to as consumer’s (Joe’s or Mary’s) “consumer equilibrium”.
Consumer Equilibrium
Price and Budget Changes
Price change, ceteris paribus
Budget change, ceteris paribus
Consumer Behavior and Demand
• An Individual Demand Curve
– Fundamental concept of economics!
– Shows the maximum quantities of a good and
individual is willing and able to buy at various prices in
a given market at a point in time, ceteris paribus.
– Ceteris paribus – other things held constant (prices of
other goods, tastes and preferences (indifference
curves), budget.
– Allow the price of one good to change and record and
plot the resulting price and quantities.
– Reflects “ law of demand”.
Deriving a Consumer’s Demand Curve
Individual Demand
Possibly, the most famous of all
microeconomic concepts.
Iluustrate’s the Law of Demand”
Shows the maximum quantities of a
good and individual is willing and able
to buy at various prices in a given
market at a point in time, ceteris
paribus.
Consumer Behavior and Demand
• A Market Demand Curve
– Market Demand Curve is the various quantities of a good that all consumers in
a market at a point in time are willing and able to buy.
– Size of a “market” varies – Newark market for pizza, United States’ market for
cars, global market for….
– Conceptually, the market demand curve is the horizontal summation of
individual demand curves, i.e., pick a price and sum the quantities.
Market Demand Curve
Market Demand Curve
Important terminology
– “a change in quantity
demanded” – a movement along
a demand curve in response to
price change
– “a change (or shift) in demand” –
a shift (in or out) of the demand
curve in response to change in
preferences, income,
expectations, prices of related
goods, income, population
– Subtle wording difference, but
different meaning.
Consumer Behavior and Demand
Market Demand “Shifters”
• Factors that Shift the Demand Curve
– Size of the Population (aka, “size of market”)
– Tastes and Preferences (see Penson et al, page 61)
– Income (budget lines)
• For most goods, increased income means increase in demand
(shift out).
• For some goods, increased income means, decrease in demand
(shift in).
– Prices of Related Goods
• Effect depend on relationship of goods – complements or
substitutes.
• Substitutes – Coke and Pepsi (for many people).
• Complements – peanut butter and jelly, bacon and eggs, etc.
– Expectations – snow storm is coming!
Elasticity (ies) of Demand
• Elasticity
–
Numerical measure of the “responsiveness” of quantity of a good demanded to a change in the price
of the good (price elasticity) or income (income elasticity).
• Price Elasticity of Demand
– Definition – numerical measure of the “responsiveness” of quantity of a good demanded to a
change in the price of the good.
– Calculation – pick two points on a demand curve (D and C) - page 56 in text.
– It is the “percent change in quantity divided by the percent change in price.”
– Interpretation – if the price of a good changes, do consumers buy a little more (or less) or a lot
more (or less).
Values for Ed
– Possibilities
• Ed is always negative (why?), so ignore the negative
sign.
• Inelastic Demand
Ed < 1
• Unitary Elasticity
Ed = 1
• Elastic Demand
Ed >1
Factors that Affect Ed
– Factors that affect Price Elasticity
• Substitutes – the more substitutes, the higher Ed
• Alternative uses – the more uses, the higher the Ed
• The larger the expenditure as a part of consumers’
budget, the higher the Ed
Effect of ED on Total Revenue
–
Why is price elasticity of goods and services important?
Engel Curve
• Engel Curve
– Similar to a demand curve, but shows the change
in quantity of a good demanded in response to a
change in income.
– Plot the tangency points on different budget lines
and indifference curves at highest levels of
satisfaction.
Derived from Budget Changes
• An Engel Curve is
derived by increasing a
consumer’s budget, and
noting the quantity of a
good that is consumed.
Budget change, ceteris paribus
Graphically,
• Engel Curve for Food
Food Purchased
• Engel Curve for Clothing
Clothing Purchased
Income
Income
Consumer Behavior and Demand
• Income Elasticity of Demand
–
–
Definition – numerical measure of the “responsiveness” of quantity of a good demanded to a change
in the consumer’s income
Calculation – pick two points on an Engel Curve (I1, Q1 and I2, Q2).
–
It is the “percent change in quantity divided by the percent change in price.”
–
Interpretation – if income changes, do consumers buy a little more (or less) or a lot more (or less) of
a good.
Graphically,
• Engel Curve for Food
Food Purchased
• Engel Curve for Clothing
Clothing Purchased
Income
Income
Income Elasticity
– Possibilities
• Income elasticity can be positive or negative, so the
sign is important.
• Normal Good
• Superior Good
• Inferior Good
Income Elasticity is between 0 and 1
Income Elasticity is > 1
Income Elasticity is < 0
– Why is this important?
• From the USDA Web Site (2003):
Consumer Behavior and Demand
• Summary
– The concept of consumer demand is used to model and measure
consumer behavior in our economic system.
– It is a fundamental part of microeconomics.
• Lecture Sources: Text and Miscellaneous Materials
• For more information, see:
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Text
Wikipedia - http://en.wikipedia.org/wiki/Consumer_theory
Wikipedia - http://en.wikipedia.org/wiki/Price_elasticity_of_demand
Wikipedia http://en.wikipedia.org/wiki/Income_elasticity_of_demand
Assignment 4 - Figure A
Assignment 4 – Figure B
Note axis change!