Consumer Theory (Applications) Tutorial 5

Page 2 Applying Consumer Theory  Using consumer theory, we can examine the changes in the consumer choices whenever there is a change in an exogenous determinant.  Study how a consumer is affected by the adoption of different pricing schemes by firms, the imposition of different government policies, and a variety of other consumer choices such as labor-leisure choice, borrowing and lending.  Applying the consumer theory, we attempt to provide answers to two main questions: -Will the consumer be better off? -How will the consumer change his consumption choice?

Page 3 Comparative Statics Analysis: Changes in Income  Suppose Income increases from I 1 to I 2 U1U1 U2U2 E2E2 x y BL 2 E1E1 BL 1 MUST the consumer be better off? How many cases we have to consider? How will the consumption choice change? Normal good? Inferior good?

Page 4 Comparative Statics Analysis: Changes in Price  Suppose price of good x decreases from to U1U1 U2U2 E2E2 x y BL 2 E1E1 BL 1 MUST the consumer be better off? How many cases we have to consider? How will the consumption choice change? Assumes Law of demand hold

Page 5 Discussion Question 2  Should you have a buffet dinner or a regular dinner? -Some restaurants offer buffet dinner. A consumer pays $200 and can consume all he wants. U1U1 E1E1 Food (dish, f) Other Good (y) BL 1 U2U2 E2E2 BL 2 I/P y (I – 200)/P y 200/P f I/P f P f /P y = 0

Page 6 Discussion Question 2  Should you have a buffet dinner or a regular dinner? -Some restaurants offer buffet dinner. A consumer pays $200 and can consume all he wants. U1U1 E1E1 Food (dish, f) BL 1 U2U2 E2E2 BL 2 I/P y (I – 200)/P y 200/P f I/P f Other Good (y)

Page 7 Discussion Question 1  Draw the indifference curve for good A and B if they are: -Perfect Substitutes -Perfect Complements  Discuss the consumer equilibrium in these cases.

Page 8 Perfect Substitutes x (e.g., distilled water) y (e.g., mineral water) U1U1 U2U2 U3U3 BL 1 BL 2 E

Page 9 Perfect Complements x (e.g., lens) y (e.g., glasses frame) U1U1 U2U2 U3U3 BL 1 BL 2 E

Page 10 Discussion Question 3  Can you benefit from the Uncle Russ Coffee’s “Chops” program? -When a consumer buys a cup of coffee at Uncle Russ Coffee, he also receives “a chop”. Uncle Russ Coffer offers a free drink for the consumers who have collected “12 chops” In other words, it is a “buy 12 get one free” program. Coffee (c) U1U1 E1E1 Other Good (y) BL 1 U2U2 E2E2 BL 2 I/P y I/P c

Page 11 Discussion Question 3  Can you benefit from the Uncle Russ Coffee’s “Chops” program? -When a consumer buys a cup of coffee at Uncle Russ Coffee, he also receives “a chop”. Uncle Russ Coffer offers a free drink for the consumers who have collected “12 chops” In other words, it is a “buy 12 get one free” program. Coffee (c) 1213 U1U1 E1E1 Other Good (y) BL 1 BL 2 I/P y I/P c

Page 12 Quantity Discount  Quantity Discount -One of the two supermarket giants, Wellcome, offered a 50% discount for the second unit a consumer buys.

Page 13 Discussion Question 4  Sichuan Earthquake Relief: In-Cash Donation vs. In-Kind Donation -After the Sichuan earthquake in May, 2008, huge amounts of donation were received from the public in Hong Kong. While many of us contributed in-cash donation, some people contributed in-kind or in-service donation. -Some organizations recommended people to contribution in-cash donation rather than in- kind donation. Why? -Let’s compare the difference between a donation of $1000 and a donation of $1000 worth food.

Page 14 Discussion Question 4 Food (f) E1E1 (I+$1000)/P y U2U2 E2E2 BL 1 BL 2 Y/P f (Y + $1000)/P f U1U1 Other Good (y) I/P y

Page 15 Discussion Question 4 Food (f) $1000/p f E1E1 (I+$1000)/P y U2U2 E2E2 BL 1 BL 2 I/P f (I + $1000)/P f U1U1 Other Good (y) I/P y BL 3

Page 16 Discussion Question 4 Food (f) E1E1 E2E2 E3E3 Y/p f (i + $1000)/p f $1000/p f (I+$1000)/P y U2U2 U3U3 BL 1 BL 2 Y/P f Other Good (y) I/P y BL 3 U1U1

Page 17 FB Essay Question  After cutting the Comprehensive Social Security Assistance (CSSA) cash allowance for the elderly (from HK$2,400 to HK$2,200) by the Social Welfare Department in early October 2005, the department is now considering to subsidize the cost of Chinese medicine consultations of elderly. It is proposed that the elderly could reimburse their cost of Chinese medicine consultations up to certain amount. a.Suppose that the upper limit of the subsidy is HK$200, which is exactly equal to the full amount of the social security cut. Use the indifference curve and budget line to show and explain the effects of the proposed policy on the elderly. b.While the pressure groups and legislators generally welcomed the proposal, they recommended the government to simplify the administrative procedures of the scheme, which makes it very hard to reimburse the full amount. Use the indifference curve and budget line to discuss the effects of the imposition of these requirements on the elderly. Do you support the imposition of these requirements?