Transcript week8-1 - GEOCITIES.ws

Chapter 5
Household behavior and
consumer choice
Circular flow
• Figure 5.1
Assumptions underlying the household
choice model:
• Households make demand decisions in
output markets, and supply decisions in
input markets.
• All input and output markets are perfectly
competitive.
• Households possess all the information they
need to make market choices.
Perfect Knowledge
• The assumption that households possess a
knowledge of the qualities and prices of
everything available in the market and that
firms have all available information
regarding wage rates, capital costs, and
output prices
Every household must make three
basic decisions:
• How much of each product to demand
• How much labor to supply
• How much money to spend today and how
much to save for the future
Review -- the determinants of
household demand:
•
•
•
•
The price of the product
The income available to the household
The household’s amount of accumulated wealth
The prices of other products available to the
household
• The household’s tastes and preferences
• The household’s expectations about future income,
wealth, and prices
Budget Constraint
• The limits imposed on household choices
by income, wealth, and product prices
Choice or Opportunity Set
• The set of options that is defined and
limited by a budget constraint
Struggling graduate students, Ann and Tom,
solving the household choice problem:
• Ann and Tom have $200 to spend each month.
• They purchase meals at the local Thai restaurant,
and trips to the local jazz club, The Hungry Ear.
• Thai meals cost $20 per couple and The Hungry
Ear costs $10 per couple.
• QUESTION: WHAT CAN ANN AND TOM
BUY WITH THEIR $200 MONTHLY
BUDGET?
To graphically depict Ann and Tom’s
budget constraint:
Jazz club visits
per month
20
If they purchase only jazz club
visits, they can purchase $200/$10,
or 20 of them.
10
If they purchase
only Thai meals, they
can purchase $200/$20,
or 10 of them.
0
10
Thai meals per month
To graphically depict Ann and Tom’s
budget constraint:
Jazz club visits
per month
20 B
Infeasible
10
Feasible
O
•Line AB represents Ann and
Tom’s budget constraint.
•The budget constraint is
linear.
•The slope of the budget
constraint represents the price
ratio of the two goods.
•The budget constraint is
NOT a demand curve.
A
10
Thai meals per month
What if the price of Thai meals falls
to $10 per couple?
Jazz club visits
per month
• Line A1B represents
Ann and Tom’s new
budget constraint.
• When the price of
one good changes,
the budget
constraint pivots.
20 B
10
O
A
10
A1
20
Thai meals per month
What if the income increases to
Jazz club visits
B2
$300?
per month 30
• Line A2B2
represents Ann
and Tom’s new
budget constraint.
• When the income
changes, the
budget constraint
shifts.
20 B
10
O
A
10
A2
15
Thai meals per month
Chapter 6
Utility
The basis of choice: Utility
• The budget constraint shows us the
combinations of two goods that a household
CAN buy...
• What else do we need to know to determine
what the household WILL buy?
Utility
• Utility: The satisfaction, or reward, a
product yields relative to its alternatives
– Impossible to measure
– Cannot be compared across people
– Helps us to better understand consumer
choice...
Total Utility vs. Marginal Utility
• Total utility is the total amount of
satisfaction obtained from consumption of a
good or service.
• Marginal utility is the additional satisfaction
gained by the consumption or use of one
more unit of a good or service.
Law of Diminishing Marginal Utility
• The more of any one good consumed in a
given period, the less satisfaction (utility)
generated by consuming each additional
(marginal) unit of the same good.
In other words
• Your order of nachos tastes great.
• Your ninth bag of nachos gives you
indigestion.
An example - Frank’s total utility and
marginal utility of trips to jazz club
• Frank’s total utility and marginal utility of
trips to club.
– Table 5.2
• Graphs of Frank’s total utility and marginal
utility
– Figure 5.5
Allocating Income to Maximize Utility
• How can we use the information on the
budget set and utility theory to determine
the utility maximizing bundle of goods and
services?
Key point -- Bang for the Buck
• We try to get the maximum
BANG FOR THE BUCK
or
BANG FOR THE HOUR
An example
• Consider Frank. He is trying to determine
the utility maximizing combination of trips
to a jazz club and basketball games to take
per week.
An example – total and marginal
utility for both trip and game
Club
Total
utility
Marginal
utility
Bball
Total
utility
Marginal
utility
1
12
12
1
21
21
2
22
10
2
33
12
3
28
6
3
42
9
4
32
4
4
48
6
5
34
2
5
51
3
6
34
0
6
51
0
Time is scarce
• Suppose Frank’s “friend” will buy tickets
for either one, every night. Time is the
scarce resource. Suppose he goes to 6 clubs,
1 game?
Time is scarce
Club
Total
utility
Marginal
utility
Bball
Total
utility
Marginal
utility
1
12
12
1
21
21
2
22
10
2
33
12
3
28
6
3
42
9
4
32
4
4
48
6
5
34
2
5
51
3
6
34
0
6
51
0
His totally utility is 34+21=55
Time is scarce
• Suppose he gives up one club, for another
game. What happens to total utility?
Club
Total
utility
Marginal
utility
Bball
Total
utility
Marginal
utility
1
12
12
1
21
21
2
22
10
2
33
12
3
28
6
3
42
9
4
32
4
4
48
6
5
34
2
5
51
3
6
34
0
6
51
0
His total utility now: 34+33=67
What allocation is best? Why?
Club
Total
utility
Marginal
utility
Bball
Total
utility
Marginal
utility
1
12
12
1
21
21
2
22
10
2
33
12
3
28
6
3
42
9
4
32
4
4
48
6
5
34
2
5
51
3
6
34
0
6
51
0
His total utility now: 28+48=76
What allocation is best? Why?
• Not consider the price of club or
basketball game, he got highest total
utility when
• He equalized Marginal utility PER
NIGHT!!
• What if we consider the problem of
price?
Utility-Maximizing Rule
• A utility maximizing consumer allocates his
or her expenditures such that the marginal
utility per dollar spent on each activity is
equal.
MUx MUy

Px
Py
Returning to Frank’s problem...
• If club trips cost $3.00 and games cost
$6.00, what will he buy for a $21 budget?
Club
Marginal
utility
MUc
Pc
Bball
Marginal
utility
MUb
Pb
1
12
4.0
1
21
3.5
2
10
3.3
2
12
2.0
3
6
2.0
3
9
1.5
4
4
1.3
4
6
1.0
5
2
0.7
5
3
0.5
6
0
0
6
0
0
Downward-Sloping Demand Revisited
D
• Diminishing marginal
utility helps to explain
why demand slopes down.
Marginal utility falls with
each additional unit
consumed, so people are
not willing to pay as
much.
Price changes affect households in two ways:
• Income effects: Consumption changes
because purchasing power changes.
• Substitution effects: Consumption changes
because opportunity costs change.
Income Effect of a Price Change
• When the price of a product falls, a
consumer has more purchasing power with
the same amount of income.
• When the price of a product rises, a
consumer has less purchasing power with
the same amount of income.
Substitution Effects of a Price Change
• When the price of a product falls, that
product becomes more attractive relative to
potential substitutes.
• When the price of a product rises, that
product becomes less attractive relative to
potential substitutes.
Review questions
•
•
•
•
Sketch budget constraints.
Know how to calculate marginal utility.
What is utility maximizing rule?
Income and substitution effects.