Unit1- 6 Consumer Theory

7/28/2019 Unit1- 6 Consumer Theory

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What is Consumer

make purposeful choices.

ssumes a consumers un ers an e r

choices (possibilities) and the pricesoppor un y cos s assoc a e w eac

choice.

Assumes that consumers consider thealternatives and choose the one they like best.

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-

to understand the foundations of market

scratch)

theory issues that are best understood

usin this model rather than the a re ate

demand model

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Two Components of

What can the consumer afford?

a are e consump on poss es

Summarized by the budget constraintPreferences:

What does the consumer like?

How much does a consumer like a good?

Summarized by the utility function

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What is a Budget

consumers purchase opportunities as

be bought at given prices using a given.

The budget constraint measures the

com na ons o purc ases a a personcan afford to make with a given amount

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o mone ary ncome.


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preferences.

mong wo un es, e one w e

higher utility is the preferred bundle. If two bundles have the same utility, we

say that the consumer is indifferent.

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Preferences that satisfy the conditions I have

noted above can be represented byindifference curves.

The set of all indifference curves that describe

an individuals preferences are referred to as.

An indifference curve connects all of the

.We will assume only two goods when using

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Indifference Curve Map -

up.

n erence curves can no cross one

another.Better bundles are to the northeast.

Indifference curves will not be bowed

out.

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Preferences in

An indifference curve connects Li's Indifference Curvesall the bundles that have the

same utility.

Higher indifference curves 25

30

indicate more utility (IC2 is

preferred to IC1).

Lower indifference curves15

20

Rice

I2

I1

I0

indicate less utility (IC1 is

preferred to IC0).

The indifference curve map is0

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FULL of indifference curves. Wheat

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The Marginal Rate of

The Marginal Rate ofLi's Indifference Curves

how much of one good aperson would willingly tradefor an incremental unit of the 25

30

other good and remainindifferent.

The MRS=|slope| of the15

20

R

ice

I2

I1

I0

n erence curve a abundle.

Common to assume the MRS 0

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an indifference curve. Wheat

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How Much Wheat and

consume is the amount that maximizesutilit sub ect to bud et constraint.

In the graph...

Get to the hi hest indifference curve ossible

Stay on the budget constraint (b/c more is

e er

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How to Find the Best

Rice The black bundle is

20

best. The pink bundle is

not the best. All

the income has

IC1

IC2

R*

not on the highest

Wheat10

IC0

W*

possible.

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How to Find the Best

the indifference curve is just tangent to the budgetline.

Utility is maximized when:

you are on the budget line and

the slope of the indifference curve equals the

slope of the budget line

y s max m ze w en: Income=PRR + PWW

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Income and Substitution

on the quantity demanded into an income and asubstitution effect.

Income effect: due to the increase in real income

associated with a fall in prices (you can buy more with

the same nominal income or the loss of real income

associated with a rise in prices (you cannot buy as much

as you once did with the same nominal income).

u s u on e ec : ue o e c ange n e re a veprice of the good, cheaper goods are substituted for

more expensive ones.

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Unit1- 6 Consumer Theory