1. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 1 Chapter 7 Consumer Behaviour

2. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 2 Learning Objectives Develop further the two explanations of the law of demand first presented in Chapter 3. Discuss the role of marginal utility in explaining consumer behaviour.

3. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 3 Learning Objectives (cont.) Describe the relationship between marginal utility and the demand curve so that we may better analyse how consumers allocate their money incomes among various goods and services. Examine the implications of the addition of the time dimension to our explanation of consumer behaviour.

4. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 4 Two Explanations of the Law of Demand 1. Based on income and substitution effects: – Income effect: the impact of a change in price on consumers real income and quantity demanded – Substitution effect: the impact of a change in price on relative expenses and quantity demanded

5. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 5 Two Explanations of the Law of Demand (cont.) 2. Based on utility theory: utility is the satisfaction a consumer obtains from consuming a good or service – Total Utility (TU) is a measure (in units called utils) of the total satisfaction derived from the consumption of a good – Marginal Utility (MU) is the extra satisfaction derived from the consumption of one additional unit of a good

6. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 6 Two Explanations of the Law of Demand (cont.) – Law of diminishing marginal utility: marginal utility will decline as the consumer acquires additional units of a particular product

7. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 7 Units of Product A Total Utility (utils) Marginal Utility (utils) First Second Third Fourth Fifth Sixth Seventh 8 7 5 3 1 0 –2 8 15 20 23 24 22

8. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 8 0 1 2 3 4 5 6 7 Units consumed (Total Utility) Units consumed (Marginal Utility) 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 –2 TU MU 1 2 3 4 5 6 7 8

9. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 9 0 1 2 3 4 5 6 7 Units consumed (Total Utility) Units consumed (Marginal Utility) 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 –2 TU MU 0.5 2 3 4 5 6 7 9

10. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 10 Theory of Consumer Behaviour Assumptions – Rational behaviour – Preferences (tastes) – Budget constraint – Prices Utility Maximising Rule – Consumer should allocate money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility

11. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 11 Product A: Price = $1Product B: Price = $2 First 10 1024 12 24 Second 8 820 10 20 Third 7 7 18 9 18 Fourth 6 616 8 16 Fifth 5 5 12 6 12 Sixth 4 4 6 3 6 Seventh 3 3 4 2 4 Unit of product Marginal utility (utils) Marginal utility per dollar (MU/price) Marginal utility (utils) Marginal utility per dollar (MU/price) Product B: Price = $1 Marginal utility per dollar (MU/price) The Utility Combination of Product A and Product B

12. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 12 Algebraic Restatement of the Utility-Maximisation Rule MU of product AMU of product B Price of APrice of B =

13. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 13 Marginal Utility and the Demand Curve Deriving the demand curve – preferences or tastes – money income – prices of other goods Create a demand schedule from the purchase decisions as the price of the product is varied

14. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 14 Indifference Curve Analysis Appendix to Chapter 7

15. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 15 Learning Objectives Introduce the concept of the budget line and explain its relationship to the prices of products and consumers' money income. Develop the concept of indifference curves. Derive a demand curve using indifference curves and budget lines.

16. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 16 The Budget Line Shows the various combinations of two products that can be purchased with a given money income Assume two products, A and B. Price of A is $1.50 per unit; price of B is $1.00 per unit. Total money income = $12.00. Various combinations of A and B, as illustrated in the following table…

17. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 17 8 0$12 6 3 12 4 6 12 2 9 12 0 12 12 Units of A Price $1.50 Units of B Price $1.00 Total Expenditures Combination of A and B Obtainable

18. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 18 The Budget Line The budget line shows the combinations of A and B obtainable given money income and prices An increase in income makes the purchase of more of either or both items possible Price changes cause a change in the quantity demanded of the items

19. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 19 (Attainable) A Consumer’s Budget Line Quantity of A Quantity of B (Unattainable) 12 10 8 6 4 2 0 2 4 6 8 10 12 Income/P A = 8 Income/P B = 12

20. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 20 Indifference Curves An indifference curve shows all combinations of products A and B that will yield the same level of satisfaction or utility to the consumer

21. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 21 An Indifference Schedule j 12 2 k 6 4 l 4 6 m 3 8 Combination Units of AUnits of B

22. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 22 I A Consumer’s Indifference Curve Quantity of A Quantity of B k l m 12 10 8 6 4 2 0 2 4 6 8 10 12 j

23. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 23 Characteristics of Indifference Curves Down-sloping Convex to origin Slope of indifference curve is the marginal rate of substitution (MRS) Indifference map is a set of indifference curves Curves further away from the origin indicate a higher level of utility

24. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 24 Indifference Map 12 10 8 6 4 2 0 2 4 6 8 10 12 Quantity of A Quantity of B I1I1 I2I2 I3I3 I4I4

25. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 25 Equilibrium Equilibrium occurs at point of maximum Total Utility (TU) Tangency solution – maximum TU is where highest indifference curve just touches the budget line

26. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 26 Consumer’s Equilibrium Quantity of A Quantity of B I1I1 I2I2 I3I3 I4I4 w x 12 10 8 6 4 2 0 2 4 6 8 10 12 z Y

27. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 27 Deriving the Demand Curve Assume the price of one good falls – the budget line pivots towards the origin of the axis whose price has fallen – the equilibrium position changes The new equilibrium involves more of the good whose P has fallen – this is the Law of Demand

28. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 28 Deriving the Demand Curve (cont.) Quantity of B I1I1 I3I3 2 4 6 8 10 12 12 10 8 6 4 2 0 Quantity of B 1 2 3 4 5 6 7 8 9 10 11 12 $1.50 1.00 0.50 D Price of B Quantity of A

29. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 7/e by Jackson and McIver Slides prepared by Muni Perumal, University of Canberra, Australia. 29 Next Chapter: An Overview of Market Structures