Transcript ECON4346 28 OCT

Consumer Behavior

Common Sense
◦ High Price discourages customers from buying
◦ Low Price encourages customers to buy

Consumer Behavior is reflected in the
Demand Curve

The change in the price of a product will have
effects on….
◦ Consumer’s real income
◦ The quantity demanded of that product


When the price of a good declines, people will
have more money to spend
My son’s allowance: $20 per week
◦ He drinks 8 Monsters a week at $2.50
◦ If price of monsters were to decrease to $2.00
 He would have $4.00 Extra!
 He can either purchase more Monsters or other goods

This is the impact that a change in product’s
price has on its relative expensiveness and on
the quantity demanded
◦ When price of a product falls, that product is now
cheaper relative to other products
◦ If Monster falls from $2.50 to $2.00, it becomes a
better buy
◦ Lower price induces my son to substitute Monsters
for other caffeinated drinks
 He will buy More of it

Mankiw’s Priniciple #3: Rational People Think
at the Margin
◦ Margin—an incremental adjustment
◦ What is the benefit of the next item consumed?
◦ What is the cost of the next item consumed?

Utility
◦ Want satisfying power

Marginal Utility is the extra satisfaction that a
person derives from an additional
consumption of one more item
Tacos Consumed Per
Meal
Total Utility Derived
“Utils”
Marginal Utility
“Utils”
0
0
1
10
10
2
18
8
3
24
6
4
28
4
5
30
2
6
30
0
7
28
-2
Total Utility
35
30
30
28
25
30
28
24
20
18
Total Utility
15
10
10
5
0
0
1
2
3
12
4
5
6
7
8
MARGINAL UTILITY
10
8
6
4
2
MARGINAL UTILITY
0
-2
-4
0
1
2
3
4
5
6
7
8
Soda Machines
Newspaper Box

Consumer behavior and equilibrium is based
on:
◦ Budget Lines
◦ Indifference Curves


Technical Constraint
Schedule or curve that shows various
combinations of two products a consumer
can purchase with specific income
Monsters
$2.50 per
Snickers
$1.00 per
Total Expenditure
8
0
$20 (=$20+0)
6
5
$20 (=$15+$5)
4
10
$20 (=$10+$10)
2
15
$20 (=$5+$15)
0
20
$20 (=0+$20)
Budget LIne: Monsters and Snickers with $20
9
Monsters
8
7
6
5
4
3
2
1
0
0
5
10
15
20
25
Snickers

Two (2) things can cause the budget line to
shift
◦ Income Changes
 Increase in income will shift the curve to the left
◦ Price Changes
 Decreases in the price of both items will shift the curve
to the left
 Change in price relative to the other will cause change
in slope


Subjective
An indifference curve shows all the
combinations of two products (A and B) that
will yield the same total satisfaction or total
utility to a consumer
Combination
Monsters
Snickers
j
12
2
k
6
4
l
4
6
m
3
8
Indifference Curve
Snickers
9
j
8
7
k
6
5
l
4
3
m
2
1
0
0
2
4
6
8
10
12
14
Monsters


Convex to origin
Slope at each point measures Marginal Rate
of Substitution
◦ Rate at which consumer will substitute one good for
the other in order to remain equally satisfied.
◦ As the amount of Monsters increases, its marginal
utility decreases
◦ As the amount of Snickers decreases, its marginal
utility increases


Curves farther from origin indicate higher
levels of total utility
Curves closer to origin represent less total
utility

The best combination is the point where the
indifference curve and the budget line are
tangent.

Demand is the quantity of a good that a
person will buy at various prices.


By varying the price of one of the goods while
holding the price of other constant, the
points of tangency will change.
This gives alternative price/quantity
combinations.

Does everyone think this way?

As Mankiw points out: No

Consumer behavior is a model
A brief overview

Total Income from sales
S
P
D
Q
REVENUE = PRICE X QUANTITY

Fixed Costs
◦ Incurred no matter what the output is
 RENT
 VEHICLES
 EQUIPMENT

Variable Costs
◦ Costs which vary per with output
 LABOR
 UTILITIES
 FUEL CONSUMPTION

TOTAL COST = FIXED + VARIABLE

Very Simple
◦ PROFIT = Revenue – Total Cost


Takes into account Explicit Costs (like an
accountant)
Also takes into account Implicit Costs
◦ Opportunity Cost
Economist
Accountant
Economic Profit
Accounting Profit
Implicit Costs
Explicit Costs
Explicit Costs


A firm’s implicit costs are the opportunity
costs of using its self-owned, self employed
resources.
To the firm, opportunity costs are the money
payments that self employed resources could
have earned in their best alternative use



You are earning $22,000 per year as a
salesperson at the Gap
You decide to open up your own store!
You have saved up $20,000 in CDs that were
paying 5% per year
◦ Use that $20K as a down-payment/initial
investment on your new store
◦ New store’s lease is $5K per year
◦ You hire clerk to help out and give her $18K
annually
Total Sales
Revenue
$120,000
Cost of Tee
Shirts
$40,000
Clerk Salary
$18,000
Utilities
$5,000
Total Explicit
Costs
$63,000
Accounting
Profit
$57,000
Looks Good…..right????
Accounting
Profit
$57,000
Foregone
Interest
$1,000
Foregone Lease
$5,000
Foregone Wages
$22,000
Foregone
Entrepreneurial
Income*
$5,000
Total Implicit
Costs
$33,000
Economic Profit
$24,000



Economic Profit is not a cost, because it is a
return in excess of the normal profit that is
required to retain the entrepreneur
Even if the Economic Profit is zero, the
entrepreneur is still covering all explicit and
implicit costs, including a normal profit.
In our example, as long as accounting profit
is $33,000 or more, you will continue to
operate