Consumer Theory-1 Lecture 12 Dr. Jennifer P. Wissink ©2018 John M. Abowd and Jennifer P. Wissink, all rights reserved. March 7, 2018

Announcements-micro Spring 2018 Wednesday regular makeup start at 3:00pm (1110 & 1120) BKL 119 – THIS ROOM HAS BEEN CHANGED TO WRN B25 Wed-day people w/accommodation letters start at 2:00pm (1110 & 1120) URH G22 New MEL Quizzes went up last night! Moving to Wednesdays as “due nights” until prelim 2. One is due Wednesday next week already (on elasticity measures) About today’s lecture and i>clicker points Today’s class will be added to the “Class Add-on” number for people who can’t make it. However, if you are here you will get the i>clicker point too!

Why Bother with Consumer Theory? The “Market Demand Function & Curve” for a single good aggregates and summarizes all market consumers’ intended purchases. “Consumer Theory” allows us to build a model from scratch to: Goal 1: Build the market demand from its core “ingredients.” Goal 2: Use the consumer theory model to address issues not adequately explained via reference to the summarized and aggregated model.

Consumer Theory Goal #1 Build the Market Demand We are going to study the demand for two goods (beans and carrots) using two different consumers (Maryclaire and Katie). For each good and each consumer, the theory produces a demand function: Demand function for beans: Bi = fB(PB, PC, I) i=Maryclaire, Katie Demand function for carrots: Ci = fC(PB, PC, I) i=Maryclaire, Katie where PB is the price of beans, PC is the price of carrots, and I is the consumer i’s income. When we properly aggregate the two consumers’ demand equations we get the market demand equations, one for beans and one for carrots.

Two Components of Consumer Demand Opportunities: What can the consumer afford? What are the consumption possibilities? Summarized by the budget constraint and budget line Preferences: What does the consumer like? How much does a consumer like a good? How would a consumer willingly trade off one good for another? Summarized by preferences, indifference curve maps and the utility function Interesting NPR Piece on “habit formation”! How You Can Harness The Power Of Habit http://www.npr.org/2012/02/27/147296743/how-you-can-harness-the-power-of-habit

What is a Budget Set and a Budget Line? A budget set shows the consumer’s purchase opportunities as every combination of two goods that can be bought at given prices using up a given amount of income. A budget line is the boundary of the budget set.

Maryclaire’s Budget Line Budget Constraint for Maryclaire when PB=$4/lb PC = $2/lb Income=$40 Beans (lbs) Carrots (lbs) 20 1 18 2 16 3 14 4 12 5 10 6 8 7 9 Suppose the following for Maryclaire: Price for Beans = $4/lb Price for Carrots = $2/lb Income = $40. The table shows the combinations of beans and carrots that Maryclaire can buy using up all her income. The mathematical expression for the budget line is:

Graph of Maryclaire’s Budget Set & Budget Line Recall the equation for the budget line: C = I/PC – (PB/PC)B Let the│slope│of the budget line be called the Economic Rate of Substitution (ERS) The ERS = 2 in this example (assuming Beans are the horizontal good and Carrots are the vertical good) . Note: if you had put Beans on the vertical and Carrots on the horizontal, then the ERS = 1/2

i>clicker question How will Maryclaire’s budget line change if just her income increases? It will get steeper. It will shift in parallel to itself. It will get flatter. It will shift out parallel to itself. It will not change.

i>clicker question How will Maryclaire’s budget line change if just the PC increases? It will get steeper. It will shift in parallel to itself. It will get flatter. It will shift out parallel to itself. It will not change.

i>clicker question How will Maryclaire’s budget line change if just the PB decreases? It will get steeper. It will shift in parallel to itself. It will get flatter. It will shift out parallel to itself. It will not change since the prices did not change.

i>clicker question How will Maryclaire’s budget line change if her income stays the same and both the price of beans and the price of carrots double? It will get steeper. It will shift in parallel to itself. It will get flatter. It will shift out parallel to itself. It will not change since the prices did not change.

More Budget Line Gymnastics $mlo The case of quantity discounts for rubber bands BLold Rubber Bands

Now Onto The Consumer’s Preferences How can we model what you like?

Preferences: Definitions A bundle of goods, G, specifies exact quantities of all the possible goods and services a consumer cares about. ASSUME: Our consumer has preferences over all the possible bundles that could be assembled. How can we define these preferences? With an “at least as good as” operator. Let R = “at least as good as” G0 R G1 means bundle G0 is “at least as good as” bundle G1 . Let I = “indifferent to” G0 I G1 means bundle G0 is “indifferent to” bundle G1 . Let S = “strictly preferred to” G0 P G1 means bundle G0 is “strictly preferred to” bundle G1 .

Assumptions on the Consumer’s (Maryclaire’s) “at least as good as” Operator A1: More is at least as good as less (monotonicity) If Y has more of at least one good than X (and no less of any other good), then Y R X If Y has more of ALL goods, then let’s agree that we will say Y is actually better than X, so then Y P X A2: Rationality (transitivity) If X R Y and Y R Z, then X R Z A3: Average bundles are at least as good as extreme bundles (convexity) If X I Y and Z is an “average” of X and Y, then Z R X and Z R Y C B C B