1. 7-1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Chapter 7 Consumer behaviour

2. 7-2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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 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

3. 7-3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Learning objectives (cont.) Examine the implications of the addition of the time dimension to our explanation of consumer behaviour

4. 7-4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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 The law of diminishing marginal utility

8. 7-8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia

9. 7-9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Theory of consumer behaviour Consumer choice and budget constraint Assumptions –Rational behaviour — consumers maximise total utility –Preferences (tastes) — clear cut preferences or tastes –Budget constraint — total money income is limited –Prices — prices are given for the consumer 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 –There will be no incentive to alter expenditure pattern. The consumer will be in equilibrium

10. 7-10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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 products A & B

11. 7-11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Algebraic restatement of the utility-maximisation rule MU of product AMU of product B Price of APrice of B =

12. 7-12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

13. 7-13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Indifference curve analysis Appendix to Chapter 7

14. 7-14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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

15. 7-15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Indifference curve analysis Explanation of consumer behaviour and consumer equilibrium based on: Budget lines –Describes the income and price constraints on consumer behaviour Indifference curves –Describes consumers taste pattern

16. 7-16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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 obtainable with an income of $12.00, are illustrated in the following table

17. 7-17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia The budget line The budget line shows the combinations of A and B obtainable given the 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. 7-19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia (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 B = 12Income/P A = 8

20. 7-20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia An indifference schedule j 12 2 k 6 4 l 4 6 m 3 8 Combination Units of AUnits of B

22. 7-22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia I A consumer’s indifference curve Quantity of A Quantity of B 12 10 8 6 4 2 0 2 4 6 8 10 12 m j k l

23. 7-23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-24 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-25 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-26 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Consumer’s equilibrium Quantity of A Quantity of B I1I1 I2I2 I3I3 I4I4 12 10 8 6 4 2 0 2 4 6 8 10 12 Y x z w

27. 7-27 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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. 7-28 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia 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 x’x

29. 7-29 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Microeconomics 8e, by Jackson & McIver By Muni Perumal, University of Canberra, Australia Next chapter: An overview of market structures