1. Consumer behavior and market demand
Lecture 5

2. The market demand
Total quantity demanded at each price, holding constant all other influences on demand, is obtained by adding the quantities demanded by all buyers at each price
The market demand curve is obtained by adding the individual demand curves of all buyers horizontally

3. Consumer’s demand
The simple model of consumer behavior: an assumption that each consumer:
- chooses quantities demanded of all goods in order to maximize his/her satisfaction, given the limits imposed by available income and prices of goods
The decisions are taken from the point of view of consumer’s own interests

4. The budget constraint
Specificies the combinations of goods the consumer can afford to buy
Graphic presentation of budget constraint
The slope of the curve: opportunity cost can be seen in the slope of budget constraint line
Tgα =Px/Py = 0O/0L
How many Y could be exchanged for one X

5. Budget constraint line income=50E, Py=10E; Px-5E

6. Budget constrant line and the increase of income

7. Budget constraint line and the change of the price

8. Features of indifference curves

9. Indifference curves
Show a set of consumption bundles among which a consumer is indifferent. All consumption bundles on an indifference curve yield the same level of utility
Indifference curve can not cross, the consumption bundle at the cross point have two utility levels – it does not make sense!
Higher indifference curves correspond to higher level of utility
Indifference curves are negatively sloped
The indifference curve first is very steep and then becomes flatter. This flattering out reflects the diminishing marginal rate of substitution
The marginal rate of substitution tells how many of good 1 one can consumer give up to get one unit of good 2 and leave utility unchanged

10. Indifference curve 2

11. Diminishing marginal rate of substitution
A – a small amount of x, it is worth a lot of good y
B - a lot of good x, it is worth a small amount of y
Consumer prefers to give up 3 films for one meal (situation A)
and 1 film only for 1 meal (situation B)
Different shapes of indifference curves : food lovers and movie lovers

12. The consumer’s behavior
Optimal consumption bundle: at the point the budget line is tangent to the highest indifference curve
It means that the slope of indifference curve equals the slope of the budget line at this point.

13. Optimal consumption bundle
At point E marginal rate of substitution ∆Y/∆X= Px/Py

14. Consumers equilibrium and change of income
1. Increase in income increases demand for normal good
The graph
2. Increase in income diminishes demand for inferior goods

15. Consumers equilibrium and a change in price
How to show on the graph the change in price?
Substitution effect of the change in price: adjustment of demand to the change in relative prices
Income effect: adjustment of the demad to the change in relative income
How to isolate substitution and income effect on the graph (hypothetical budget constrant line; paralel shift)

16. Giffen paradox
inferior goods: increase in price -substitution effect diminishes demand
But in some cases (very rare) income effect being result of the lower relative income could be so strong that demand for the good will grow although its price has grown

17. Income and substitution effect of the price increase versus cross elasticity of the demand
Negative cross elasticity of demand (films-meals): income effect stronger than substitution effect- more expensive meals decrease demand for cinema tickets
Positive cross elasticity of demand (bread-other food): more expensive bread increases demand for other food. It means that substitution effect stronger than income effect

18. Impact of the price increase of good „i” on the demad for „i” and „j” goods
Assumed type
Substitution effect
Income effect
Total effect i
normal
negative
inferior
positive
? Although usually negative j ?
Inferior