(consumer behavior (chapter 3

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لحعجصمح() عا با ‎Vopios‏ "3 ‏ووو جوو0)‎ PrePerewesr ® Bucket Cousiraicts "3 Couwer Choice 0۳ 9: ‏و0‎ 2 Oke S 

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لحعجصمح() عا با ‎Vopios‏ © Dargie tity ond Conmuiver Okvives a Cost-vP-Livicry dodexes ۱ 0۳ 9: ‏و0‎ 2 Oke SD 

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Oowsurver Oekwior © Pwo upplicatioes thot thusteote the inmportcae DP the evouwir thepry oP poosuver belkavirr Nine: © @ppte-Ciseenood Okrerivs © The Pood Gtawp Progra. 0۳ 9: ‏و0‎ 2 Oke 

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Oowsurver Oekwior ® Gecerd ils hed to detercoiae how high o Prive to charge Por @pple-Ciccracpoa Cheerivs bePore it weet to the warket. 0۳ 9: ‏و0‎ 2 Oke S 

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Oowsurver Oekwior ® Qkeu the Pood stp prope wos potublished to the pady (Q0Os, the desiquers hed to detercotag to what exteat the Pood ed unt just sisoply subsidize the Pood they 0۳ 9: ‏و0‎ 2 Oke Oo 

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Oowsurver Oekwior 6 2 و0 :9 0۳ 

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Oowsurver Oekwior ® OD here we thee steps volved in the sty oP powanver behwior. 0) Ov wil study cousuver preferewes. Do describe how ued why people prePer vor youd to cother. 0۳ 9: ‏و0‎ 2 Oke O 

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Oowsurver Oekwior ® OD here we thee steps volved in the sty oP powanver behwior. 5) reo we vill ture to budget 171751-01. * People kave hevited ome. 0۳ 9: ‏و0‎ 2 Oke SO 

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Oowsurver Oekwior ® OD here we thee steps volved in the sty oP * Okat cowbicativd oP yoods wil posers buy ‏شوه وا نموه و‎ 0 ۵ 2 و0 :9 0۳ 

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۱0۳ PrePereuwes Onrket Ooshets ۱ ) ‏اون‎ boshet is u oollevtiva oP vue or wore powwodilies. ® Oe worket bushet wap be prePered per ‏بو اون‎ busket pootaiciagy a diPR erect 0۳ 9: ‏و0‎ 2 Olde 0 

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۱0۳ PrePereuwes | Ossucvpives 0) rePerewes ure ‏ام‎ ‎wood to less.‏ نوه ‎0۳ 9: ‏و0‎ 2 Oke IC ‎ ‎ ‎ 

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Oowsurver PrePereuwes ‎eke Outsoh Pood Outs of Chtkcy‏ وا( ‎0 ‎۵ ‎ ‎co ‎do ‎FO ‎90 ‎do ‎do ‎Oo ‎0 ‎0 ‎2 ‎0 ‏ناك‎ ‏2 و0 :9 0۳ ‎ 

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Oowsurver PrePereuwes ‎Ouves:‏ هبو( ‎ ‎ ‎8 odiPPereuwe curves represect ull the suve level oP sutisPuntivg to 0 persvu. ‏»۵ 2 و0 :9 0۳ ‎ ‎ ‎ 

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۵» 2 و0 :9 0۳ ۰0 & preferred O, Weld the ‏متسد سود‎ Ovwhrnts 8,0, & D ‘Ope prePerredic L & 8 

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Oowsurver PrePereuwes © 4odiPPerewe Curves © dadPRereure curves slope doweward to the right. OP it stoped upward it would vickate the ussuwpiiod that wore oP ‏دا نل جومت روي‎ prePerred to fess. ع0 عبت 2 و0 :9 0۳ 

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Oowsurver PrePereuwes ‎4dodPPerewe Ouves‏ ا" ‎Oa worket busket voy above ed ty the right oF‏ و ‎tuo fodiPPereure purve is prePened to coy warket‏ ‎curve.‏ لین ‎basket that lies va the‏ ‏0 »۵۷ 2 و0 :9 0۳ ‎ 

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۱0۳ PrePereuwes ۶() مهو( " ‏ال اه او ها وت الب جب8)‎ purves thut describes u persvu's prePereuves Por ‏موی اه‎ oP two vowwodliies. © Gock indPPereue curve io the wap shows the wurket buskets aoa whick the persva i= 0۳ 9: ‏و0‎ 2 Oke 1S 

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Oowsurver PrePereuwes © dodPRereause Ouves © Piodly, indPPereuwse vores ont poss. ‏یت نا موجه با اش لور با‎ is preferred to less. 60 ۵ 2 و0 :9 0۳ 

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Orbs bust @ we prefered @. Oaths butt Oe prePered ts O. Oke Od 2 و0 :9 0۳ 

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60-66 2 و0 :9 0۳ 

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Oowsurver PrePereuwes QDargcrd Rae oF Gubsttutiod ® Dke worqied rote oP substiuican (DRG) quodiPies the onoud oP oe yood uo poasuner vil give up ‏لوص ای خن و تیان ما‎ ۱ iotP Renee DIE. 0۳ 9: ‏و0‎ 2 Obde OF 

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Oowsurver PrePereuwes QDargcrd Rae oF Gubsttutiod a Ov wil cow odd o Pourk ossucoptiod ‏رو زر‎ pousuwer prePereuce! © loo oa tod Rereuse curve there is a + ‏رو(‎ the DRG Por @@ was O, while that Por DE wes 2 ی 2 و0 :9 0۳ 

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Oowsurver PrePereuwes QDargcrd Rae oF Gubsttutiod © Qvuesiod © kat we the Pirst three ussucvpiives? 0۳ 9: ‏و0‎ 2 Oke OP 

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۱0۳ PrePereuwes QOarqed Que oP Gubstrutoa 8 dodPPereuwe curves ure cowex bevousr us wore oP poe youd is cousnved, ‏كك‎ 705179 would prePer to que up Rewer wits oP o ‏با لوب مود‎ yet odditiccal ucts oP the Pirst pw. ® Oowsanvers prefer u bolrosed warket basket 0۳ 9: ‏و0‎ 2 Oke CO 

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Oowsurver PrePereuwes QDargcrd Rae oF Gubsttutiod # Perfent Gubstiutes ond PerPevt Oovwpleweuts ‎qoods we perPent substitutes whea the‏ رز و ‎warqicd rote oP substituiod oP mae youd Por the‏ ‎0۳ 9: ‏و0‎ 2 Obte SS ‎ ‎ ‎ 

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Oowsurver PrePereuwes QDargcrd Rae oF Gubsttutiod # Perfent Gubstiutes ond PerPevt Oovwpleweuts ‎Pwo woods we perPent cowplewedts whea the‏ و ‎iodPPereuce curves Por the woods ure skhuped us‏ ‏0 »۵ 2 و0 :9 0۳ ‎ ‎ ‎ 

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hice (chores) ‏هج‎ 

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Obte SE ares i 9 ae \ 9 0 68 9 ] ‏ری‎ Choe 2 و0 :9 0۳ 

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Oowsurver PrePereuwes ٩ 0005 ۱ ® Cxanples © ir ‏ای‎ ‎© ) ‏وصوص راد‎ 9 ی 2 و0 :9 0۳ 

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Oowsurver PrePereuwes ™ Oka Ov You Thick? ow on we woot Por Buds io the ‏خام جور اهمه‎ 7 + ‏وه اس‎ ( 0۳ 9: ‏و0‎ 2 Obde OE 

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Oowsurver PrePereuwes QDestaitcay Dew @uoxovbles (1) © Qupwoble exevuiives wust recudy decide whe to foicoduce ce wodels ued kow work woury ty vest it nestplicey. ۱ ی 2 و0 :9 0۳ 

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Oowsurver PrePereuwes QDestaitcay Dew @uoxovbles (1) ۴ )(۰ ‏تردن‎ oP power prePereuves would kelp to detercvice Whe ced iP por powpodies should chooge the sipliog oP their mars. ۱ 0۳ 9: ‏ی 2 و0‎ SO 

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لعج 09 سره Wk ORG hese rowers re ‏سب ها متس‎ 7 ‏سمتسستا‎ ۱ Sas 0۳ 9: ‏و0‎ 2 Ore 0 

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۱ = 0۳ 9: ‏و0‎ 2 Ore SO 

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Oowsurver PrePereuwes QDestaitcay Dew @uoxovbles (1) ™ Oka Ov You Thick? © ‏وراك‎ oon we deterring he poo ers 9 ی 2 و0 :9 0۳ 

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۱0۳ PrePereuwes QDestaitcay Dew @uoxovbles (1) #0 revedt study oP ‏مجح موی‎ ict the Onvited Gtotes shows thot over the post tuo ‏اوه ولمم‎ poosuvers hue prePerred ۱ 0۳ 9: ‏و0‎ 2 ۵ FO 

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Oowsurver PrePereuwes 17۳۲۷ QDestaitcay Dew @uoxovbles (1) ® Growt oP daporese * (97 O's un 09© ‏ج00‎ *1S% oP dowesiic rors werdernwedt ‏صابك ه‎ chooge pack peor ¢ Dhis cowpures ty CO% Por ixoporis 9 0 2 و0 :9 0۳ 

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Oowsurver PrePereuwes © Ditty © Oily: Ouwercd score represeutocgy the soisPuctivg that poosuver yets Poo a yivedt worket basket. لب 2 و0 :9 0۳ 

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Oowsurver PrePereuwes © Ditty OP buyin O copies oP ‏جعاد وده جد ددموز(1)‎ wokes pou khuppier thea bupiegy var shin, thea we say thot the books qive pou wore uly thao the shirt. 0۳ 9: ‏و0‎ 2 Obde PS 

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Oowsurver PrePereuwes © Ost» Pucctivas ۰ ‏مس رواب 2 مسق‎ Por Pood (P) ued ‏واه‎ ‎(C) @c)=e+eC0 Ourket Baskets! P waits OC units O(P,C) =P +OC ۳72-۳0۳ ۳ 6 ۳ كت ۳ 0 6 8 e ‏م«‎ 6 + )6( - 48 The ‎Dhe oowanver‏ 0 0 در مه ۰ موه ‎prefers 0 & Ot O ‏© ی 2 و0 :9 0۳ ‎ ‎ ‎ ‎ 

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‎IedPPerewe Ourves‏ & ی( ربلا( ‎ ‎ ‏ما0 ‏عم ‎zane: 0 = PO‏ رس ‎Ourket Basket 0 < 0‏ \ ‎as \ 0 99 <‏ ‎8S)‏ \ ‎eS =S(S)‏ © ۷ - هه هال 0 (©:0)6 (ي0 ط لمحتس ”ا) 000- و0 ‎Ba‏ ‎Og =80 (Preferred 0(‏ 0,26 0 1 ‎ond‏ 1 ‎(waite per week) ‎ ‎ ‎ ‎Obde PS ‎ ‎ 

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۱0۳ PrePereuwes ۴ ‏لسن‎ Orrsus Curcdicral ety ® Ordicd Otlity Pucctica: places warket baskets ia the order oP ost prePerred ty leust prePerred, but it does ant iodicate ‏یمن تیم‎ oe aarket bushet is prePenced to wovther. ® Cardi Oily uccion! utility ‏تسیل مت‎ the exteat to Wwhiok poe warhket busket is prePerred ty covtker. 0۳ 9: ‏و0‎ 2 Obde FO 

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۱0۳ PrePereuwes ® Orde Orr Cardi Ruch © Phe ucted uct oP weasurewent Por uly i ut 0 ‏صا تیه ها بو ام و ری و‎ ع دی 2 و0 :9 0۳ 

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جاده 02 اصل:9) وی و و او امه صل دصرم رص جرت ا" ‎bekavior.‏ ‏حا ره مه ‎Qudget pocstroiats ubsy beri‏ © ubiliy to poosucve to light oP the prices they 0۳ 9: ‏و0‎ 2 Ore FO 

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جاده 02 اصل:9) 9 ۱۱ Bucket Lice © Phe budget hoe iodicates ofl powbicaives oP iow powwodiies Por whick tot ocey spect equals total ioe. 0۳ 9: ‏و0‎ 2 Obde FO 

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جاده 02 اصل:9) 9 ۱۱ Bucket Lice bet P equdl the oud oP Pood purchused, ocd C is the awoud oP ‏ای‎ © Price oP Pood =P, ocd price oF ‏نام‎ = P, © Phea P, Pig the aooudt of wou sped oo Pood, and PO is the caoudt ‏اه رو اه‎ © rApthicrey. 0 »۵ 2 و0 :9 0۳ 

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جاده 02 اصل:9) © De bucket fee theo coo be vores PrP + 6 < [ 2 و0 :9 0۳ 

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جاده 02 اصل:9) م6 ۵( (6) میات ‎Pood (P)‏ سایق یلو 21 0 ,۳ )$2(=@ )$0(= ,@ 6 0600 0 66 9050 0 6 ۵9060 0 0 6000© 0 6 600 60 وس رم سح ‎٩9:‏ 

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جاده 02 اصل:9) 2 0,280 89عیم 290 00 عدا على @ Co ‏هم‎ ‎Oow wer Behar Obte SO‏ :9 بان ‎ ‎ ‎ 

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جاده 02 اصل:9) 9 ۱۱ Bucket Lice © )95 ‏رواد ورس بمادرجسكجمون‎ a budeet fice ‏ما‎ ‎the iutercept, the poosuver speuds less vo vor Phe slope of the foe weusures the ‏رشاو‎ ost oF Pood ord clothicry. oP the tuvy «yoods. eq eq ی 2 و0 :9 0۳ 

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جاده 02 اصل:9) 9 ۱۱ Bucket Lice © ‏بای وموك جو"‎ the rote of whick the two qoods coc be substituted without choagiccy the avo oF wouey sped. 0۳ 9: ‏و0‎ 2 Obte SS 

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جاده 02 اصل:9) 9 Bucket Lice © Phe veriiod intercept (WP), tistrotes the i aout bP O that coo be purckosed wis ore ‘1. © Phe horizvcte ictervept (VP q), thistrates the wurtwud aout oP CP that cod be purchased wis ove ‘1. 0۳ 9: ‏و0‎ 2 Obte SO 

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جاده 02 اصل:9) ® Dke @RRects ‏له وا و م6 هن‎ Prices © hooowe Charnes * Oo reuse in ‏مج و‎ the budget tice to sh cutuvard, parcel to the vrigicral fice (koldicry 0۳ 9: ‏و0‎ 2 Ore SP 

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جاده 02 اصل:9) ® Dke @RRects ‏له وا و م6 هن‎ Prices © hooowe Charnes 90 depreuse in wows vouses the budket fee t7 sh iad, parcel to the vrigictal fae (holder 0۳ 9: ‏و0‎ 2 Ore SO 

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O roreer ۰ eoowe shPe ‏لیصا‎ 

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جاده 02 اصل:9) ® Dke @RRects ‏له وا و م6 هن‎ Prives ° Prive Changes: ۰/۱ ‏با‎ prive oP cae yood immreuses, the budget foe shits icpvard, ‏بستنم‎ Prov the vier xpos intercept. 0 »۵ 2 و0 :9 0۳ 

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جاده 02 اصل:9) ® Dke @RRects ‏له وا و م6 هن‎ Prices ° Prive Changes: » OP the price oP var yood decreuses, the budget ۱ Prov the other xpos intercept. 0۳ 9: ‏و0‎ 2 Oke Od 

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9 ‏اه سبط‎ ‏مساج‎ oP Boxed Ge $.90 chomer ‏وراد صا‎ oP ie bucket hoe ord متفه ۱ سیر Pood (vcs per week) See 190 وس 

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جاده 02 اصل:9) 8 ‏بب۱/‎ GPPevts ‏اجه جوا و 0 خان‎ Prices ° Prive Changes: °1P the tlw yoods inoreuse iu price, but the rofiz DFP the tio prices is vackoaged, the slope will ‏.سعد ات‎ ی 2 و0 :9 0۳ 

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جاده 02 اصل:9) له وا و م6 هن ‎Dke @RRects‏ ® ‎Prices‏ © Price Charnes * Wowever, the budget foe will shi inward to a ‏ارم‎ porcbel to the vrigicral bucket fice. 0۳ 9: ‏و0‎ 2 Obde OF 

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جاده 02 اصل:9) ® Dke @RRects ‏له وا و م6 هن‎ Prices ° Prive Changes: ۰/۱۳ ‏رم و حول ون مر با‎ but the rofiz oF the tivo prices is vockoaged, the slope 0۳ 9: ‏لب 2 و0‎ OS 

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جاده 02 اصل:9) له وا و م6 هن ‎Dke @RRects‏ ® ‎Prices‏ © Price Charnes هط توش تاه ان وتا ایلیا سا رورا ‎porcbel to the vrigicral bucket fice.‏ ارم ی 2 و0 :9 0۳ 

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Couwnuwer Ohvive ® Oocsunvers choose ‏اجه موس و‎ thot wil worxieize the sutisPuctivg they mort uhieve, qive the lievited budget avaiable tz عه ل 2 و0 :9 0۳ 

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Couwnuwer Ohvive ‎woarket busket wust sotishy‏ موب ‎Phe‏ "ا جک با ‎be located va the budget lice.‏ ۹( ‎bP yoods oad‏ نامر ‎prePerred‏ ‎51217725. ‎0۳ 9: ‏و0‎ 2 Oke OO ‎ 

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۱0 Choice Reval, the slope ‏وس( جه خام‎ pure is: 1 Obte OS AC MRS=- — AF Pe Slope-- (urtker, ۱ م29 و0 :9 بان 

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Couwnuwer Ohvive 9 Therefore, See eet Cee rea Se 0 9: ‏م2 موه‎ Ode TO 

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Couwnuwer Ohvive 94 coc be suid thot sufsPantiva is ‏لو‎ ‎O) 6 equal to the rota oP the prices (oP Pood 0) 0 »۷ 2 و0 :9 0۳ 

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o eo 0 60 Pood (ctr per werk) 0۳ 9: ‏و0‎ 2 Oke TO 

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۱0 Choice ‎P,=$0 1=‏ 89عوم ‎ae‏ ‎per‏ ‏30 عند 0 ساسا بو 0 تست ‎eon he veredt‏ ی لیا رای( سر رس ری ۳ ‎OOM‏ 0 60 © ‎ ‎0۳ 9: ‏و0‎ 2 Oe TS ‎ ‎ ‎ ‎ ‎ 

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Oowsurver Choire © Covsider two yours oP ‏اوه ,موه‎ wiskiay t7 sped $10, DOO vu the stpliccy cord ‏وم هم‎ oF pars. ® Gack your kes dP Perec prePereuces. ۱ 0۳ 9: ‏و0‎ 2 Oe 7S 

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Oowsurver Choire ® Op Proctor the potot oP toogeuppy ‏ده حون‎ ‏ی له من‎ ced the budget powstroat ‏نت‎ powpodies coo designe a ۱ 0۳ 9: ‏و0‎ 2 Ore TO 

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‎Ori Durables (41)‏ ت00 ‎ ‎ ‎ ‏2 و0 :9 0۳ ‎ ‎ ‎ 

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‎Ori Durables (41)‏ ت00 ‎ ‎ ‎ ‏و۳۶۲ 800,000 $9,000 ‎۵ TO ‏2 و0 :9 0۳ ‎ ‎ ‎ 

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Oowsurver Choire QDevision Dubie & Publis Poioy ® Choosing betweed ‏له سوه وه‎ wwutchiey yc to Puerd police expestdituces 0۳ 9: ‏و0‎ 2 Oke TS 

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0۳ 9: ‏و0‎ 2 Ore OO 

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0 20 ون 6 © porcer ooltiog exists Po ‏جح‎ buys io extrenves, werd buys ull oP coe voteyory oP qpood ced aoe pe covther. ‏و‎ VD his exists where the indPPereore purves ure foogeut to the korizvotal cod vertical unde. © DRGs ‏مت وا مج سب‎ عبت ‎Brlvasor‏ و0 :09 

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0۳ 9: ‏و0‎ 2 Ore OS 

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Couwnuwer Ohvive 2 Concer Golation © Bt poict , the ORG oP ive crea Por Prozeo powurt is qreuter thao the slope oP the budget fae. © This suqqests that iP the poosuwer could give up swore Prozeo pos Por ioe ‏موه‎ ke would do BU. © Wowever, there is uw wore Prozes pox ‏صا‎ vive | wp! 0۳ 9: ‏و0‎ 2 Ore OO 

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Couwnuwer Ohvive 2 Concer Golation © Okeo u porcer svluicd wises, he ‏جود وس‎ ORG des wt cevessoriy equdl the price raiv. 84a this ‏موز‎ tt ooo be suid that! MRS Foe ‏عم‎ ۳ 0۳ 9: ‏و0‎ 2 Oke OF 

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Couwnuwer Ohvive 9 ) Corcer Gohativa OAR the ORG ws, in Pont, sigqnPicadty yreuter tho the price roc, thea o soul depreuse in the price ‏ام‎ Prozes posurt wil aot dter he poosuer’s warket basket. 0۳ 9: ‏و0‎ 2 Okt 66 

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Couwnuwer Ohvive ® Ovleye Trist Pucd ® Suppose dace Ove’s pareets set up trust 9 ‏رازب‎ the woury weet be used Por education. 0۳ 9: ‏و0‎ 2 Ore 9 

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Couwnuwer Ohvive ® Ovleye Trist Pucd BP pont of the wouery could be used Por the purchase oP other yoods, ker poususpptios 0۳ 9: ‏و0‎ 2 ۵» OD 

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Oowsurver Choire ‎Trist Puc‏ باون ظ) ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎@: Cousucoption bePore the trust Pucrd he trust Pued shits the budget foe 00: ‏مس0‎ fret fee cet raced 1 operand C2 1P tke trust could be spect oo ‏حي جه‎ ‎ ‎ ‎ 

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BP we ‏و ون وا زر‎ power hus ۱ What her prePereuves ure iP we hove icPorevotiod bout ‏موی تایه وه‎ oF choices that ane woude wheo prives und owes voy. 0۳ 9: ‏و0‎ 2 Obte SS 

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Qeveded PrePerewes-- Two Oudcet bices Pood (uate per wouk) و ی 2 و0 :9 0۳ 

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Qeveded PrePerewes-- Pwo Budcet Lices Pood (uate per wouk) 0۳ 9: ‏و0‎ 2 Obde OF 

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Qeveded PrePerewss Por Qeoreuioa “The rete ‏و وا‎ 90 + 360/2۷ *Orw bucket ee 1, 3 ‏ماه‎ 0 *Reved prePerewe of Ow ® ‎Ohb’s‏ حا لدج( سس ۳ ‏موه «سمو ‎(ere)‏ هم ‏و ی ‎— ‎*Roberta'» ‏لعج‎ < 9100 ۰۳ oP exoroee = $Pikofwook ‏با ,0 صف 0 ف شا 0( ‎*Crercere‏ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ ‎ 

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Darqycra ‏له ربا(‎ Cowsnnver Chvive © Qarged! utliy weasures the odditiocral sulisPuction obtoiced Proow poosusviey oo uddiiocal weit oP a youd. 0۳ 9: ‏و0‎ 2 Ore O? 

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Darqycra ‏له ربا(‎ Cowsnnver Chvive Darqd Oily © Exavple © Phe ‏مومت‎ uty ‏رو مت مرب‎ Pro 0 ۲ ) ‏ی‎ oP Pood wight be O ‏متسب و‎ Prow (to © wight be ‏م4‎ ‎© dooreusiagy Prow © ty OD wight be © © Observation: Dargical utliiy is diovicishicry 0۳ 9: ‏و0‎ 2 Ore SO 

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Chapter 3 Consumer Behavior Topics to be Discussed  Consumer Preferences  Budget Constraints  Consumer Choice  Revealed Preferences Chapter 3: Consumer Behavior Slide 2 Topics to be Discussed  Marginal Utility and Consumer Choices  Cost-of-Living Indexes Chapter 3: Consumer Behavior Slide 3 Consumer Behavior  Two applications that illustrate the importance of the economic theory of consumer behavior are:  Apple-Cinnamon  The Cheerios Food Stamp Program. Chapter 3: Consumer Behavior Slide 4 Consumer Behavior  General Mills had to determine how high a price to charge for Apple-Cinnamon Cheerios before it went to the market. Chapter 3: Consumer Behavior Slide 5 Consumer Behavior  When the food stamp program was established in the early 1960s, the designers had to determine to what extent the food stamps would provide people with more food and not just simply subsidize the food they would have bought anyway. Chapter 3: Consumer Behavior Slide 6 Consumer Behavior  These two problems require an understanding of the economic theory of consumer behavior. Chapter 3: Consumer Behavior Slide 7 Consumer Behavior  There are three steps involved in the study of consumer behavior. We will study consumer preferences. 1)  To describe how and why people prefer one good to another. Chapter 3: Consumer Behavior Slide 8 Consumer Behavior  There are three steps involved in the study of consumer behavior. Then we will turn to budget constraints. 2)  People have limited incomes. Chapter 3: Consumer Behavior Slide 9 Consumer Behavior  There are three steps involved in the study of consumer behavior. 3) Finally, we will combine consumer preferences and budget constraints to determine consumer choices.  What combination of goods will consumers buy to maximize their satisfaction? Chapter 3: Consumer Behavior Slide 10 Consumer Preferences Market Market Baskets Baskets  A market basket is a collection of one or more commodities.  One market basket may be preferred over another market basket containing a different combination of goods. Chapter 3: Consumer Behavior Slide 11 Consumer Preferences Market Market Baskets Baskets  Three Basic Assumptions 1) Preferences are complete. 2) Preferences are transitive. 3) Consumers always prefer more of any good to less. Chapter 3: Consumer Behavior Slide 12 Consumer Preferences Market Basket Units of Food Units of Clothing A 20 30 B 10 50 D 40 20 E 30 40 G 10 20 H 10 40 Chapter 3: Consumer Behavior Slide 13 Consumer Preferences Indifference Indifference Curves Curves  Indifference curves represent all combinations of market baskets that provide the same level of satisfaction to a person. Chapter 3: Consumer Behavior Slide 14 Consumer Preferences Clothing (units per week) 50 B 40 H The consumer prefers A to all combinations in the blue box, while all those in the pink box are preferred to A. E A 30 D G 20 10 10 Chapter 3: Consumer Behavior 20 30 40 Food (units per week) Slide 15 Consumer Preferences Clothing (units per week) B 50 40 Combination B,A, & D yield the same satisfaction •E is preferred to U1 •U1 is preferred to H & G H E A 30 D 20 G U1 10 10 Chapter 3: Consumer Behavior 20 30 40 Food (units per week) Slide 16 Consumer Preferences  Indifference Curves  Indifference curves slope downward to the right. If it sloped upward it would violate the assumption that more of any commodity is preferred to less. Chapter 3: Consumer Behavior Slide 17 Consumer Preferences  Indifference Curves  Any market basket lying above and to the right of an indifference curve is preferred to any market basket that lies on the indifference curve. Chapter 3: Consumer Behavior Slide 18 Consumer Preferences Indifference Indifference Maps Maps  An indifference map is a set of indifference curves that describes a person’s preferences for all combinations of two commodities.  Each indifference curve in the map shows the market baskets among which the person is indifferent. Chapter 3: Consumer Behavior Slide 19 Consumer Preferences  Indifference Curves  Finally, indifference curves cannot cross. This would violate the assumption that more is preferred to less. Chapter 3: Consumer Behavior Slide 20 Consumer Preferences Clothing (units per week) Market basket A is preferred to B. Market basket B is preferred to D. D B A U3 U2 U1 Food (units per week) Chapter 3: Consumer Behavior Slide 21 Consumer Preferences Clothing (units per week) U2 Indifference Curves Cannot Cross U1 The consumer should be indifferent between A, B and D. However, B contains more of both goods than D. A B D Food (units per week) Chapter 3: Consumer Behavior Slide 22 Consumer Preferences A Clothing 16 (units per week) 14 Observation: The amount of clothing given up for a unit of food decreases from 6 to 1 12 -6 10 B 1 8 -4 6 Question: Does this relation hold for giving up food to get clothing? D 1 -2 4 E 1 -1 G 1 2 1 2 Chapter 3: Consumer Behavior 3 4 5 Food (units per week) Slide 23 Consumer Preferences Marginal Marginal Rate Rate of of Substitution Substitution  The marginal rate of substitution (MRS) quantifies the amount of one good a consumer will give up to obtain more of another good.  It is measured by the slope of the indifference curve. Chapter 3: Consumer Behavior Slide 24 Consumer Preferences A Clothing 16 (units per week) 14 MRS C MRS = 6 F 12 -6 10 B 1 8 -4 6 D MRS = 2 1 -2 4 E 1 -1 G 1 2 1 2 Chapter 3: Consumer Behavior 3 4 5 Food (units per week) Slide 25 Consumer Preferences Marginal Marginal Rate Rate of of Substitution Substitution  We will now add a fourth assumption regarding consumer preference: Along an indifference curve there is a diminishing marginal rate of substitution.  Note the MRS for AB was 6, while that for DE was 2. Chapter 3: Consumer Behavior Slide 26 Consumer Preferences Marginal Marginal Rate Rate of of Substitution Substitution  Question What are the first three assumptions? Chapter 3: Consumer Behavior Slide 27 Consumer Preferences Marginal Marginal Rate Rate of of Substitution Substitution  Indifference curves are convex because as more of one good is consumed, a consumer would prefer to give up fewer units of a second good to get additional units of the first one.  Consumers prefer a balanced market basket Chapter 3: Consumer Behavior Slide 28 Consumer Preferences Marginal Marginal Rate Rate of of Substitution Substitution  Perfect Substitutes and Perfect Complements  Two goods are perfect substitutes when the marginal rate of substitution of one good for the other is constant. Chapter 3: Consumer Behavior Slide 29 Consumer Preferences Marginal Marginal Rate Rate of of Substitution Substitution  Perfect Substitutes and Perfect Complements  Two goods are perfect complements when the indifference curves for the goods are shaped as right angles. Chapter 3: Consumer Behavior Slide 30 Consumer Preferences Apple Juice (glasses) 4 Perfect Perfect Substitutes Substitutes 3 2 1 0 1 Chapter 3: Consumer Behavior 2 3 4 Orange Juice (glasses) Slide 31 Consumer Preferences Left Shoes 4 Perfect Perfect Complements Complements 3 2 1 0 1 Chapter 3: Consumer Behavior 2 3 4 Right Shoes Slide 32 Consumer Preferences  BADS Things  for which less is preferred to more Examples Air pollution Asbestos Chapter 3: Consumer Behavior Slide 33 Consumer Preferences  What Do You Think? How can we account for Bads in the analysis of consumer preferences? Chapter 3: Consumer Behavior Slide 34 Consumer Preferences Designing Designing New New Automobiles Automobiles ((II))  Automobile executives must regularly decide when to introduce new models and how much money to invest in restyling. Chapter 3: Consumer Behavior Slide 35 Consumer Preferences Designing Designing New New Automobiles Automobiles ((II))  An analysis of consumer preferences would help to determine when and if car companies should change the styling of their cars. Chapter 3: Consumer Behavior Slide 36 Consumer Preferences Styling Consumer Consumer Preference Preference A A:: High High MRS MRS These consumers are willing to give up considerable styling for additional performance Performance Chapter 3: Consumer Behavior Slide 37 Consumer Preferences Styling Consumer Consumer Preference Preference B: B: Low Low MRS MRS These consumers are willing to give up considerable performance for additional styling Performance Chapter 3: Consumer Behavior Slide 38 Consumer Preferences Designing Designing New New Automobiles Automobiles ((II))  What Do You Think? How can we determine the consumers preference? Chapter 3: Consumer Behavior Slide 39 Consumer Preferences Designing Designing New New Automobiles Automobiles ((II))  A recent study of automobile demand in the United States shows that over the past two decades most consumers have preferred styling over performance. Chapter 3: Consumer Behavior Slide 40 Consumer Preferences Designing Designing New New Automobiles Automobiles ((II))  Growth of Japanese Imports 1970’s and 1980’s  15% of domestic cars underwent a style change each year  This compares to 23% for imports Chapter 3: Consumer Behavior Slide 41 Consumer Preferences  Utility  Utility: Numerical score representing the satisfaction that a consumer gets from a given market basket. Chapter 3: Consumer Behavior Slide 42 Consumer Preferences  Utility buying 3 copies of Microeconomics makes you happier than buying one shirt, then we say that the books give you more utility than the shirt.  If Chapter 3: Consumer Behavior Slide 43 Consumer Preferences  Utility Functions  Assume: (C) The utility function for food (F) and clothing U(F,C) = F + 2C Market Baskets: F units C units U(F,C) = F + 2C A 8 3 8 + 2(3) = 14 B 6 4 6 + 2(4) = 14 C 4 4 4 + 2(4) = 12 The consumer is indifferent to A & B The consumer prefers A & B to C Chapter 3: Consumer Behavior Slide 44 Consumer Preferences Utility UtilityFunctions Functions&&Indifference IndifferenceCurves Curves Clothing (units per week) Assume: U = FC Market Basket U = FC C 25 = 2.5(10) A 25 = 5(5) B 25 = 10(2.5) 15 10 C 5 0 U3 = 100 (Preferred to U2) A B 5 Chapter 3: Consumer Behavior 10 15 U2 = 50 (Preferred to U1) U1 = 25 Food (units per week) Slide 45 Consumer Preferences  Ordinal Versus Cardinal Utility  Ordinal Utility Function: places market baskets in the order of most preferred to least preferred, but it does not indicate how much one market basket is preferred to another.  Cardinal Utility Function: utility function describing the extent to which one market basket is preferred to another. Chapter 3: Consumer Behavior Slide 46 Consumer Preferences  Ordinal Versus Cardinal Rankings  The actual unit of measurement for utility is not important.  Therefore, an ordinal ranking is sufficient to explain how most individual decisions are made. Chapter 3: Consumer Behavior Slide 47 Budget Constraints  Preferences do not explain all of consumer behavior.  Budget constraints also limit an individual’s ability to consume in light of the prices they must pay for various goods and services. Chapter 3: Consumer Behavior Slide 48 Budget Constraints  The Budget Line  The budget line indicates all combinations of two commodities for which total money spent equals total income. Chapter 3: Consumer Behavior Slide 49 Budget Constraints  The Budget Line  Let F equal the amount of food purchased, and C is the amount of clothing.  Price of food = Pf and price of clothing = Pc Pf F is the amount of money spent on food, and Pc C is the amount of money spent on clothing.  Then Chapter 3: Consumer Behavior Slide 50 Budget Constraints  The budget line then can be written: PFF  PCC  I Chapter 3: Consumer Behavior Slide 51 Budget Constraints Market Basket Food (F) Pf = ($1) Clothing (C) Pc = ($2) A 040 $80 B 2030 $80 D 4020 $80 E 6010 $80 G 800 Chapter 3: Consumer Behavior Total Spending Pf F + P c C = I $80 Slide 52 Budget Constraints Clothing (units per week) Pc = $2 Pf = $1 I= $80 Budget Line F + 2C = $80 (I/PC) = 40 A 1 Slope C/F  - - PF/PC 2 B 30 10 20 D 20 E 10 G 0 20 Chapter 3: Consumer Behavior 40 60 80 = (I/PF) Food (units per week) Slide 53 Budget Constraints  The Budget Line  As consumption moves along a budget line from the intercept, the consumer spends less on one item and more on the other.  The slope of the line measures the relative cost of food and clothing.  The slope is the negative of the ratio of the prices of the two goods. Chapter 3: Consumer Behavior Slide 54 Budget Constraints  The Budget Line  The slope indicates the rate at which the two goods can be substituted without changing the amount of money spent. Chapter 3: Consumer Behavior Slide 55 Budget Constraints  The Budget Line  The vertical intercept (I/PC), illustrates the maximum amount of C that can be purchased with income I.  The horizontal intercept (I/PF), illustrates the maximum amount of F that can be purchased with income I. Chapter 3: Consumer Behavior Slide 56 Budget Constraints  The Effects of Changes in Income and Prices  Income  Changes An increase in income causes the budget line to shift outward, parallel to the original line (holding prices constant). Chapter 3: Consumer Behavior Slide 57 Budget Constraints  The Effects of Changes in Income and Prices  Income  Changes A decrease in income causes the budget line to shift inward, parallel to the original line (holding prices constant). Chapter 3: Consumer Behavior Slide 58 Budget Constraints Clothing (units per week) A increase in income shifts the budget line outward 80 60 A decrease in income shifts the budget line inward 40 20 L3 (I = $40) 0 L1 (I = $80) 40 Chapter 3: Consumer Behavior 80 120 L2 (I = $160) 160 Food (units per week) Slide 59 Budget Constraints  The Effects of Changes in Income and Prices  Price  Changes If the price of one good increases, the budget line shifts inward, pivoting from the other good’s intercept. Chapter 3: Consumer Behavior Slide 60 Budget Constraints  The Effects of Changes in Income and Prices  Price  Changes If the price of one good decreases, the budget line shifts outward, pivoting from the other good’s intercept. Chapter 3: Consumer Behavior Slide 61 Budget Constraints Clothing (units per week) An increase in the price of food to $2.00 changes the slope of the budget line and rotates it inward. A decrease in the price of food to $.50 changes the slope of the budget line and rotates it outward. 40 L3 (PF = 2) L1 L2 (PF = 1) 40 Chapter 3: Consumer Behavior 80 (PF = 1/2) 120 160 Food (units per week) Slide 62 Budget Constraints  The Effects of Changes in Income and Prices  Price  Changes If the two goods increase in price, but the ratio of the two prices is unchanged, the slope will not change. Chapter 3: Consumer Behavior Slide 63 Budget Constraints  The Effects of Changes in Income and Prices  Price  Changes However, the budget line will shift inward to a point parallel to the original budget line. Chapter 3: Consumer Behavior Slide 64 Budget Constraints  The Effects of Changes in Income and Prices  Price  Changes If the two goods decrease in price, but the ratio of the two prices is unchanged, the slope will not change. Chapter 3: Consumer Behavior Slide 65 Budget Constraints  The Effects of Changes in Income and Prices  Price  Changes However, the budget line will shift outward to a point parallel to the original budget line. Chapter 3: Consumer Behavior Slide 66 Consumer Choice  Consumers choose a combination of goods that will maximize the satisfaction they can achieve, given the limited budget available to them. Chapter 3: Consumer Behavior Slide 67 Consumer Choice  The maximizing market basket must satisfy two conditions: 1) It must be located on the budget line. 2) Must give the consumer the most preferred combination of goods and services. Chapter 3: Consumer Behavior Slide 68 Consumer Choice Recall, the slope of an indifference curve is: C MRS F Further, the slope of the budget line is: PF Slope PC Chapter 3: Consumer Behavior Slide 69 Consumer Choice  Therefore, it can be said that satisfaction is maximized where: PF MRS PC Chapter 3: Consumer Behavior Slide 70 Consumer Choice  It can be said that satisfaction is maximized when marginal rate of substitution (of F and C) is equal to the ratio of the prices (of F and C). Chapter 3: Consumer Behavior Slide 71 Consumer Choice Pc = $2 $80 Clothing (units per week) Pf = $1 I= Point B does not maximize satisfaction because the MRS (-(-10/10) = 1 is greater than the price ratio (1/2). 40 30 B -10C Budget Line 20 U1 +10F 0 20 Chapter 3: Consumer Behavior 40 80 Food (units per week) Slide 72 Consumer Choice Clothing (units per week) Pc = $2 $80 Pf = $1 I= 40 Market basket D cannot be attained given the current budget constraint. D 30 20 U3 Budget Line 0 20 Chapter 3: Consumer Behavior 40 80 Food (units per week) Slide 73 Consumer Choice Pc = $2 $80 Clothing (units per week) Pf = $1 I= At market basket A the budget line and the indifference curve are tangent and no higher level of satisfaction can be attained. 40 30 A At A: MRS =Pf/Pc = .5 20 U2 Budget Line 0 20 Chapter 3: Consumer Behavior 40 80 Food (units per week) Slide 74 Consumer Choice Designing Designing New New Automobiles Automobiles ((II II))  Consider two groups of consumers, each wishing to spend $10,000 on the styling and performance of cars.  Each group has different preferences. Chapter 3: Consumer Behavior Slide 75 Consumer Choice Designing Designing New New Automobiles Automobiles ((II II))  By finding the point of tangency between a group’s indifference curve and the budget constraint auto companies can design a production and marketing plan. Chapter 3: Consumer Behavior Slide 76 Designing New Automobiles (II) Styling $10,000 These consumers are willing to trade off a considerable amount of styling for some additional performance $3,000 $7,000 $10,000 Performance Chapter 3: Consumer Behavior Slide 77 Designing New Automobiles (II) Styling These consumers are willing to trade off a considerable amount of performance for some additional styling $10,000 $7,000 $3,000 Chapter 3: Consumer Behavior $10,000 Performance Slide 78 Consumer Choice Decision Decision Making Making && Public Public Policy Policy  Choosing between a non-matching and matching grant to fund police expenditures Chapter 3: Consumer Behavior Slide 79 Consumer Choice Non-matching Non-matching Grant Grant Private Expenditures ($) Before Grant • Budget line: PQ •A: Preference maximizing market basket •Expenditure •OR: Private •OS: Police P R A U1 O S Chapter 3: Consumer Behavior Q Police Expenditures ($) Slide 80 Consumer Choice Non-matching Non-matching Grant Grant Private Expenditures ($) T After Grant • Budget line: TV •B: Preference maximizing market basket •Expenditure •OU: Private •OZ: Police P U R B A U3 U1 O S Chapter 3: Consumer Behavior Z Q V Police Expenditures ($) Slide 81 Consumer Choice Matching Matching Grant Grant Private Expenditures ($) T Before Grant • Budget line: PQ • A: Preference maximizing market basket After Grant •C: Preference maximizing market basket Expenditures •OW: Private •OX: Police P W R A C U2 U1 O S Chapter 3: Consumer Behavior X Q R Police ($) Slide 82 Consumer Choice Matching Matching Grant Grant Private Expenditures ($) T Nonmatching Grant •Point B •OU: Private expenditure •OZ: Police expenditure Matching Grant •Point C •OW: Private expenditure •OX: Police expenditure P U W B A C U U23 U1 O Z X Chapter 3: Consumer Behavior Q R Police ($) Slide 83 Consumer Choice A A Corner Corner Solution Solution  A corner solution exists if a consumer buys in extremes, and buys all of one category of good and none of another.  This exists where the indifference curves are tangent to the horizontal and vertical axis.  MRS is not equal to PA/PB Chapter 3: Consumer Behavior Slide 84 A Corner Solution Frozen Yogurt (cups monthly) A U1 U2 U3 B Chapter 3: Consumer Behavior A corner solution exists at point B. Ice Cream (cup/month) Slide 85 Consumer Choice  A Corner Solution point B, the MRS of ice cream for frozen yogurt is greater than the slope of the budget line.  At  This suggests that if the consumer could give up more frozen yogurt for ice cream he would do so.  However, there is no more frozen yogurt to give up! Chapter 3: Consumer Behavior Slide 86 Consumer Choice  A Corner Solution a corner solution arises, the consumer’s MRS does not necessarily equal the price ratio.  When  In this instance it can be said that: MRSPIceCream/ PFrozenYogurt Chapter 3: Consumer Behavior Slide 87 Consumer Choice  A Corner Solution  If the MRS is, in fact, significantly greater than the price ratio, then a small decrease in the price of frozen yogurt will not alter the consumer’s market basket. Chapter 3: Consumer Behavior Slide 88 Consumer Choice A A College College Trust Trust Fund Fund  Suppose Jane Doe’s parents set up a trust fund for her college education.  Originally, the money must be used for education. Chapter 3: Consumer Behavior Slide 89 Consumer Choice A A College College Trust Trust Fund Fund  If part of the money could be used for the purchase of other goods, her consumption preferences change. Chapter 3: Consumer Behavior Slide 90 Consumer Choice Other Consumption ($) A A College College Trust Trust Fund Fund A: Consumption before the trust fund The trust fund shifts the budget line B: Requirement that the trust fund must be spent on education U3 C: If the trust could be spent on other goods C P A B U2 U1 Q Chapter 3: Consumer Behavior Education ($) Slide 91 Revealed Preferences  If we know the choices a consumer has made, we can determine what her preferences are if we have information about a sufficient number of choices that are made when prices and incomes vary. Chapter 3: Consumer Behavior Slide 92 Revealed Preferences-Two Budget Lines Clothing (units per month) l1 l2 I1: Chose A over B A is revealed preferred to B l2: Choose B over D B is revealed preferred to D A B D Food (units per month) Chapter 3: Consumer Behavior Slide 93 Revealed Preferences-Two Budget Lines Clothing (units per month) l1 All market baskets in the pink shaded area are preferred to A. l2 A B B is preferred to all market baskets in the green area D Food (units per month) Chapter 3: Consumer Behavior Slide 94 Revealed Preferences-Four Budget Lines I3: E revealed preferred to A Clothing (units per month) l3 l1 All market baskets in the pink area preferred to A E l4 A l2 B A: preferred to all market baskets in the green area Chapter 3: Consumer Behavior G I4: G revealed preferred to A Food (units per month) Slide 95 Revealed Preferences for Recreation Scenario •Roberta’s recreation budget = $100/wk •Price of exercise = $4/hr/week •Exercises 10 hrs/wk at A given U1 & I1 Other Recreational Activities ($) 100 C 80 60 A 40 •The rate changes to $1/hr + $30/wk •New budget line I2 & combination B •Reveal preference of B to A B U1 U2 Would the Club’s profits increase? 20 l1 0 25 Chapter 3: Consumer Behavior l2 50 75 Amount of Exercise (hours) Slide 96 Marginal Utility and Consumer Choice Marginal Marginal Utility Utility  Marginal utility measures the additional satisfaction obtained from consuming one additional unit of a good. Chapter 3: Consumer Behavior Slide 97 Marginal Utility and Consumer Choice Marginal Marginal Utility Utility  Example  The marginal utility derived from increasing from 0 to 1 units of food might be 9   Increasing from 1 to 2 might be 7  Increasing from 2 to 3 might be 5 Observation: Marginal utility is diminishing Chapter 3: Consumer Behavior Slide 98 Marginal Utility and Consumer Choice Diminishing Diminishing Marginal Marginal Utility Utility  The principle of diminishing marginal utility states that as more and more of a good is consumed, consuming additional amounts will yield smaller and smaller additions to utility. Chapter 3: Consumer Behavior Slide 99 Marginal Utility and Consumer Choice  Marginal Utility and the Indifference Curve  If consumption moves along an indifference curve, the additional utility derived from an increase in the consumption one good, food (F), must balance the loss of utility from the decrease in the consumption in the other good, clothing (C). Chapter 3: Consumer Behavior Slide 100 Marginal Utility and Consumer Choice  Formally: 0 MUF(F)  MUC(C) Chapter 3: Consumer Behavior Slide 101 Marginal Utility and Consumer Choice  Rearranging:   C / F  MUF / MUC Chapter 3: Consumer Behavior Slide 102 Marginal Utility and Consumer Choice   C / F  MUF / MUC  Because:   C / F  MRSof Ffor C MRS MUF/MUC Chapter 3: Consumer Behavior Slide 103 Marginal Utility and Consumer Choice  When consumers maximize satisfaction the: MRS PF/PC  Since the MRS is also equal to the ratio of the marginal utilities of consuming F and C, it follows that: MUF/MUC  PF/PC Chapter 3: Consumer Behavior Slide 104 Marginal Utility and Consumer Choice  Which gives the equation for utility maximization: MUF / PF MUC / PC Chapter 3: Consumer Behavior Slide 105 Marginal Utility and Consumer Choice  Total utility is maximized when the budget is allocated so that the marginal utility per dollar of expenditure is the same for each good.  This is referred to as the equal marginal principle. Chapter 3: Consumer Behavior Slide 106 Marginal Utility and Consumer Choice Gasoline Gasoline Rationing Rationing  In 1974 and again in 1979, the government imposed price controls on gasoline.  This resulted in shortages and gasoline was rationed. Chapter 3: Consumer Behavior Slide 107 Marginal Utility and Consumer Choice Gasoline Gasoline Rationing Rationing  Nonprice rationing is an alternative to market rationing.  Under one form everyone has an equal chance to purchase a rationed good.  Gasoline is rationed by long lines at the gas pumps. Chapter 3: Consumer Behavior Slide 108 Marginal Utility and Consumer Choice  Rationing hurts some by limiting the amount of gasoline they can buy.  This can be seen in the following model.  It applies to a woman with an annual income of $20,000. Chapter 3: Consumer Behavior Slide 109 Marginal Utility and Consumer Choice  The horizontal axis shows her annual consumption of gasoline at $1/gallon.  The vertical axis shows her remaining income after purchasing gasoline. Chapter 3: Consumer Behavior Slide 110 Marginal Utility and Consumer Choice Spending on other goods ($) 20,000 18,000 15,000 A D With a limit of 2,000 gallons, the consumer moves to a lower indifference curve (lower level of utility). C U1 U2 B 2,000 5,000 Chapter 3: Consumer Behavior 20,000 Gasoline (gallons per year) Slide 111 Cost-of-Living Indexes  The CPI is calculated each year as the ratio of the cost of a typical bundle of consumer goods and services today in comparison to the cost during a base period. Chapter 3: Consumer Behavior Slide 112 Cost-of-Living Indexes  What Do You Think? Does the CPI accurately reflect the cost of living for retirees? Is it appropriate to use the CPI as a cost-of-living index for other government programs, for private union pensions, and for other private wage agreements? Chapter 3: Consumer Behavior Slide 113 Cost-of-Living Indexes  Example  Two sisters, Rachel and Sarah, have identical preferences.  Sarah began college in 1987 with a $500 discretionary budget.  In 1997, Rachel started college and her parents promised her a budget that was equivalent in purchasing power. Chapter 3: Consumer Behavior Slide 114 Cost-of-Living Indexes Price of books 1987 (Sarah) 1997 (Rachel) $20/book $100/book Number of books 15 6 Price of food $2.00/lb. $2.20/lb Pounds of food 100 300 Expenditure $500 $1,260 Chapter 3: Consumer Behavior Slide 115 Cost-of-Living Indexes Sarah’ Expenditure $500 = 100 lbs. of food x $2.00/lb. + 15 books x $20/book Rachel’ Expenditure for Equal Utility $1,260 = 300 lbs. of food x $2.20/lb. + 6 books x $100/book Chapter 3: Consumer Behavior Slide 116 Cost-of-Living Indexes  The ideal cost-of-living adjustment for Rachel is $760.  The ideal cost-of-living index is $1,260/$500 = 2.52 or 252.  This implies a 152% increase in the cost of living. Chapter 3: Consumer Behavior Slide 117 Cost-of-Living Indexes Books (per quarter) 25 For Rachel to achieve the same level of utility as Sarah, with the higher prices, her budget must be sufficient to allow her to consume the bundle shown by point B. U1 20 15 A 10 B 5 l1 l2 0 50100200250300350400450500550600 Chapter 3: Consumer Behavior Food (lb./quarter) Slide 118 Cost-of-Living Indexes  The ideal cost of living index represents the cost of attaining a given level of utility at current (1997) prices relative to the cost of attaining the same utility at base (1987) prices. Chapter 3: Consumer Behavior Slide 119 Cost-of-Living Indexes  To do this on an economy-wide basis would entail large amounts of information.  Price indexes, like the CPI, use a fixed consumption bundle in the base period.  Called a Laspeyres price index Chapter 3: Consumer Behavior Slide 120 Cost-of-Living Indexes Laspeyres Laspeyres Index Index  The Laspeyres index tells us:  The amount of money at current year prices that an individual requires to purchase the bundle of goods and services that was chosen in the base year divided by the cost of purchasing the same bundle at base year prices. Chapter 3: Consumer Behavior Slide 121 Cost-of-Living Indexes  Calculating Rachel’s Laspeyres cost of living index Setting the quantities of goods in 1997 equal to what were bought by her sister, but setting their prices at their 1997 levels result in an expenditure of $1,720 (100 x 2.20 + 15 x $100) Chapter 3: Consumer Behavior Slide 122 Cost-of-Living Indexes  Her cost of living adjustment would now be $1,220.  The Laspeyres index is: $1,720/$500 = 344.  This overstates the true cost-of-living increase. Chapter 3: Consumer Behavior Slide 123 Cost-of-Living Indexes Books (per quarter) 25 Using the Laspeyres index results in the budget line shifting up from I2 to I3. U1 20 15 A 10 B 5 l1 l3 l2 0 50100200250300350400450500550600 Chapter 3: Consumer Behavior Food (lb./quarter) Slide 124 Cost-of-Living Indexes  What Do You Think? Does the Laspeyres index always overstate the true cost-of-living index? Chapter 3: Consumer Behavior Slide 125 Cost-of-Living Indexes  Yes!  The Laspeyres index assumes that consumers do not alter their consumption patterns as prices change. Chapter 3: Consumer Behavior Slide 126 Cost-of-Living Indexes  Yes!  By increasing purchases of those items that have become relatively cheaper, and decreasing purchases of the relatively more expensive items consumers can achieve the same level of utility without having to consume the same bundle of goods. Chapter 3: Consumer Behavior Slide 127 Cost-of-Living Indexes  The Paasche Index  Calculates the amount of money at current-year prices that an individual requires to purchase a current bundle of goods and services divided by the cost of purchasing the same bundle in the base year. Chapter 3: Consumer Behavior Slide 128 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Both indexes involve ratios that involve today’s current year prices, PFt and PCt.  However, the Laspeyres index relies on base year consumption, Fb and Cb.  Whereas, the Paasche index relies on today’s current consumption, Ft and Ct . Chapter 3: Consumer Behavior Slide 129 Cost-of-Living Indexes  Then a comparison of the Laspeyres and Paasche indexes gives the following equations: PFtFt  PCtCt LI  PFtFt  PCtCt PFbFt  PCtCt PI  PFbFt  PCtCt Chapter 3: Consumer Behavior Slide 130 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Suppose: Two goods: Food (F) and Clothing (C) Chapter 3: Consumer Behavior Slide 131 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Let: PFt & PCt be current year prices PFb & PCb be base year prices  Ft &  Ct be current year quantities Fb & Cb be base year quantities Chapter 3: Consumer Behavior Slide 132 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Sarah (1990) Cost of base-year bundle at current prices equals $1,720 (100 lbs x $2.20/lb + 15 books x $100/book) Cost of same bundle at base year prices is $500 (100 lbs x $2.00/lb + 15 books x $20/book) Chapter 3: Consumer Behavior Slide 133 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Sarah (1990) $1,720 LI  344 $500 Chapter 3: Consumer Behavior Slide 134 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Sarah (1990) Cost of buying current year bundle at current year prices is $1,260 (300 lbs x $2.20/lb + 6 books x $100/book) Cost of the same bundle at base year prices is $720 (300 lbs x $2/lb + 6 books x $20/book) Chapter 3: Consumer Behavior Slide 135 Cost-of-Living Indexes Comparing Comparing the the Two Two Indexes Indexes  Sarah (1990) $1,260 PI  175 $720 Chapter 3: Consumer Behavior Slide 136 Cost-of-Living Indexes The The Paasche Paasche Index Index  The Paasche index will understate the cost of living because it assumes that the individual will buy the current year bundle in the base year. Chapter 3: Consumer Behavior Slide 137 Cost-of-Living Indexes  In 1995, the government adopted the chainweighted price index to deflate its measure of real GDP.  Developed to overcome problems that arose when long-term comparisons of GDP were made using fixed-weight price indexes and prices were rapidly changing. Chapter 3: Consumer Behavior Slide 138 Cost-of-Living Indexes The The Bias Bias of of the the CPI CPI  What Do You Think? What is the impact on the Federal budget of using the CPI (a Laspeyres index) to adjust social security and other programs for changes in the cost of living? Chapter 3: Consumer Behavior Slide 139 Summary  People behave rationally in an attempt to maximize satisfaction from a particular combination of goods and services.  Consumer choice has two related parts: the consumer’s preferences and the budget line. Chapter 3: Consumer Behavior Slide 140 Summary  Consumers make choices by comparing market baskets or bundles of commodities.  Indifference curves are downward sloping and cannot intersect one another.  Consumer preferences can be completely described by an indifference map. Chapter 3: Consumer Behavior Slide 141 Summary  The marginal rate of substitution of F for C is the maximum amount of C that a person is willing to give up to obtain one additional unit of F.  Budget lines represent all combinations of goods for which consumers expend all their income. Chapter 3: Consumer Behavior Slide 142 Summary  Consumers maximize satisfaction subject to budget constraints.  The theory of revealed preference shows how the choices that individuals make when prices and income vary can be used to determine their preferences. Chapter 3: Consumer Behavior Slide 143 End of Chapter 3 Consumer Behavior