Ch05:household behavior and consumer choice
Upcoming SlideShare
Loading in...5
×
 

Ch05:household behavior and consumer choice

on

  • 631 views

Ch05:household behavior and consumer choice

Ch05:household behavior and consumer choice

Statistics

Views

Total Views
631
Views on SlideShare
631
Embed Views
0

Actions

Likes
0
Downloads
53
Comments
0

0 Embeds 0

No embeds

Accessibility

Upload Details

Uploaded via as Microsoft PowerPoint

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment
  • Information of household income and wealth, together with information on product prices, makes it possible to distinguish those combinations of goods and services that are affordable from those that are not.
  • Information of household income and wealth, together with information on product prices, makes it possible to distinguish those combinations of goods and services that are affordable from those that are not.

Ch05:household behavior and consumer choice Ch05:household behavior and consumer choice Presentation Transcript

  • CHAPTERCHAPTER 5© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairHousehold Behaviorand Consumer ChoiceAppendix: Indifference CurvesPrepared by: Fernando QuijanoPrepared by: Fernando Quijanoand Yvonn Quijanoand Yvonn Quijano
  • CHAPTER5CHAPTER52 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairUnderstanding the Microeconomyand the Role of GovernmentPart Two Part ThreeChapter 5 Chapters 7-8 Chapters 12-15Household Behavior• Demand in outputmarkets• Supply in inputmarketsEquilibriumin CompetitiveOutput Markets• Short run• Long run Chapter 11Market Imperfectionsand the Role ofGovernment• Imperfect marketstructures• Externalities, publicgoods, imperfectinformation, socialchoice• Income distributionand povertyChapters 6-7 Chapters 9-10The CompetitiveMarket System• Generalequilibrium andefficiencyFirm Behavior• Choice oftechnology• Supply in outputmarkets• Demand in inputmarketsCompetitiveInput Markets• Labor/land• Capital
  • CHAPTER5CHAPTER53 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairFirm and Household Decisions• Householdsdemand in outputmarkets andsupply labor andcapital in inputmarkets. View slide
  • CHAPTER5CHAPTER54 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAssumptions• A key assumption in the studyof household and firm behavioris that all input and outputmarkets are perfectlycompetitive. View slide
  • CHAPTER5CHAPTER55 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAssumptions• Perfect competition is an industrystructure in which there are manyfirms, each small relative to theindustry, producing virtually identical(or homogeneous) products and inwhich no firm is large enough tohave any control over price.
  • CHAPTER5CHAPTER56 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAssumptions• We also assume that householdsand firms possess all the informationthey need to make market choices.• Perfect knowledge is the assumptionthat households posses a knowledge ofthe qualities and prices of everythingavailable in the market, and that firmshave all available informationconcerning wage rates, capital costs,and output prices.
  • CHAPTER5CHAPTER57 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairHousehold Choice in Output Markets• Every household must makethree basic decisions:1.How much of each product, oroutput, to demand.2.How much labor to supply.3.How much to spend today andhow much to save for the future.
  • CHAPTER5CHAPTER58 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Determinants of Household Demand(as seen in Chapter 3)• The price of the product in question.• The income available to the household.• The household’s amount of accumulated wealth.• The prices of related products available to thehousehold.• The household’s tastes and preferences.• The household’s expectations about future income,wealth, and prices.Factors that influence the quantity of a given good orservice demanded by a single household include:
  • CHAPTER5CHAPTER59 of© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Budget Constraint• The budget constraintrefers to the limits imposedon household choices byincome, wealth, and productprices.• A choice set or opportunityset is the set of options thatis defined by a budgetconstraint.
  • CHAPTER5CHAPTER510© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Budget Constraint• A budget constraintseparates thosecombinations of goodsand services that areavailable, given limitedincome, from those thatare not.• The availablecombinations make upthe opportunity set.
  • CHAPTER5CHAPTER511© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Budget ConstraintPossible Budget Choices of a Person Earning$1,000 Per Month After TaxesOPTION RENT FOOD OTHER TOTAL AVAILABLE?A $ 400 $250 $350 $1,000 YesB 600 200 200 1,000 YesC 700 150 150 1,000 YesD 1,000 100 100 1,200 No• The real cost of a good or service is itsopportunity cost, and opportunity cost isdetermined by relative prices.
  • CHAPTER5CHAPTER512© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Budget Constraint• This is the budgetconstraint when incomeequals $200 dollars permonth, the price of jazzclub visits is $10 each, andthe price of a Thai meal is$20.• One of the possiblecombinations is 5 Thaimeals and 10 Jazz clubvisits per month.
  • CHAPTER5CHAPTER513© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Budget Constraint• Point E is unattainablegiven the current incomeprices.• Point D does not exhaustthe entire incomeavailable.
  • CHAPTER5CHAPTER514© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Budget Constraint• A decrease in the price ofThai meals shifts thebudget line outward alongthe horizontal axis.• The decrease in the priceof one good expands theconsumer’s opportunity set.
  • CHAPTER5CHAPTER515© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Basis of Choice: Utility• Utility is the satisfaction, orreward, a product yieldsrelative to its alternatives.The basis of choice.• Marginal utility is theadditional satisfaction gainedby the consumption or use ofone more unit of something.
  • CHAPTER5CHAPTER516© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDiminishing Marginal Utility• The law of diminishingmarginal utility:The more of one goodconsumed in a given period,the less satisfaction (utility)generated by consumingeach additional (marginal)unit of the same good.
  • CHAPTER5CHAPTER517© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDiminishing Marginal Utility• Total utility increases at adecreasing rate, whilemarginal utility decreases.Total Utility and Marginal Utility ofTrips to the Club Per WeekTRIPS TOCLUBTOTALUTILITYMARGINALUTILITY1 12 122 22 103 28 64 32 45 34 26 34 0
  • CHAPTER5CHAPTER518© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairDiminishing Marginal Utilityand Downward-Sloping Demand• Diminishing marginalutility helps to explain whydemand slopes down.• Marginal utility falls witheach additional unitconsumed, so people arenot willing to pay as much.
  • CHAPTER5CHAPTER519© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairIncome and Substitution Effects• The income effect:Consumption changesbecause purchasing powerchanges.• The substitution effect:Consumption changesbecause opportunity costschange.Price changes affect households in twoways:
  • CHAPTER5CHAPTER520© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairIncome and Substitution Effectsof a Price Change (for normal goods)Income effect:• When the price of aproduct falls, a consumerhas more purchasingpower with the sameamount of income.• When the price of aproduct rises, a consumerhas less purchasing powerwith the same amount ofincome.Substitution effect:• When the price of aproduct falls, that productbecomes more attractiverelative to potentialsubstitutes.• When the price of aproduct rises, that productbecomes less attractiverelative to potentialsubstitutes.
  • CHAPTER5CHAPTER521© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairIncome and Substitution Effectsof a Price Change (for normal goods)
  • CHAPTER5CHAPTER522© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairConsumer Surplus• Consumer surplus is the differencebetween the maximum amount aperson is willing to pay for a goodand its current market price.• Consumer surplus measurement is akey element in cost-benefitanalysis—the formal technique bywhich the benefits of a public projectare weighed against its costs.
  • CHAPTER5CHAPTER523© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Diamond/Water Paradox• Water is plentiful.• If the price of water waszero, you might argue thatwater has no value. But itdoes. Consumers enjoy ahuge consumer surplusfrom water consumption.• Household willingness topay far exceeds the zeroprice.
  • CHAPTER5CHAPTER524© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Diamond/Water ParadoxThe lesson of the diamond/waterparadox is that:1. the things with the greatest valuein use frequently have little or novalue in exchange, and2. the things with the greatest valuein exchange frequently have littleor no value in use.
  • CHAPTER5CHAPTER525© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairHousehold Choice in Input Markets1. Whether to work2. How much to work3. What kind of a job to work atThese decisions are affected by:1. The availability of jobs2. Market wage rates3. The skill possessed by thehouseholdAs in output markets, households faceconstrained choices in input markets.They must decide:
  • CHAPTER5CHAPTER526© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Price of Leisure• The wage rate can be thought of as theprice—or the opportunity cost– of thebenefits of either unpaid work or leisure.Average hourly earnings of production or non-supervisory workers on non-farm payrolls in Februaryof 2003Hourly wage rateAverage—all workers $15.08Construction workers 18.20Manufacturing 15.58Excluding overtime 14.84Retail Trade 10.22Finance, Insurance and Real Estate 16.76
  • CHAPTER5CHAPTER527© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Trade-Off Facing Households• The decision to enter the workforce involves a trade-off between wages on the one hand, and leisure andthe value of nonmarket production on the other.
  • CHAPTER5CHAPTER528© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairThe Labor Supply Curve• The labor supply curveis a diagram that showsthe quantity of laborsupplied at differentwage rates.
  • CHAPTER5CHAPTER529© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairIncome and SubstitutionEffects of a Wage Change• An increase in the wage rate affectshouseholds in two ways, known as thesubstitution and income effects.• The substitution effect of ahigher wage means that theopportunity cost of leisure ishigher. The household will buyless leisure (supply more labor).• When the substitution effectoutweighs the income effect,the labor supply curve slopesupward.
  • CHAPTER5CHAPTER530© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairIncome and SubstitutionEffects of a Wage Change• An increase in the wage rate affectshouseholds in two ways, known as thesubstitution and income effects.• The income effect of a higherwage means that householdscan afford to buy more leisure(offer less labor).• When the income effectoutweighs the substitutioneffect, the result is a“backward-bending” laborsupply curve.
  • CHAPTER5CHAPTER531© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairSaving and Borrowing:Present Versus Future Consumption• Households can use present income tofinance future spending (i.e., save), or theycan use future funds to finance presentspending (i.e., borrow).• The financial capital market is thecomplex set of institutions in whichsuppliers of capital (households that save)and the demand for capital (business firmsthat invest) interact.
  • CHAPTER5CHAPTER532© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairSaving and Borrowing:Present Versus Future Consumption• In deciding how much to save and howmuch to spend today, interest rates definethe opportunity cost of present consumptionin terms of foregone future consumption.Sample interest rates early in 2003Interest RateNational average on bank money market accounts 0.74%Two-year treasury notes 1.75%Ten-year treasury bonds 4.10%National average on new car loans 7.77%30-year fixed rate mortgage 5.92%
  • CHAPTER5CHAPTER533© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairSaving and Borrowing:Present Versus Future Consumption• Income effect: Households will nowearn more on all previous savings, sothey will save less.• Substitution effect: The opportunitycost of present consumption is nowhigher; given the law of demand, thehousehold will save more.An increase in the interest rate also hassubstitution and income effects, as follows:
  • CHAPTER5CHAPTER534© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairReview Terms and Conceptsbudget constraintbudget constraintchoice set or opportunity setchoice set or opportunity setconsumer surplusconsumer surpluscost-benefit analysiscost-benefit analysisdiamond/water paradoxdiamond/water paradoxfinancial capital marketfinancial capital markethomogeneous productshomogeneous productsincome effect of a price changeincome effect of a price changelabor supply curvelabor supply curvelaw of diminishing marginal utilitylaw of diminishing marginal utilitymarginal utilitymarginal utilityperfect competitionperfect competitionperfect knowledgeperfect knowledgesubstitution effect of a price changesubstitution effect of a price changetotal utilitytotal utilityutilityutilityutility-maximizing ruleutility-maximizing rule
  • CHAPTER5CHAPTER535© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAppendix: Indifference Curves• An indifference curveis a set of points , eachpoint representing acombination of goodsX and Y, all of whichyields the same totalutility.• The consumer isworse of at A’ than atA.
  • CHAPTER5CHAPTER536© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAppendix: Indifference Curves• A preference map is awhole set of indifferencecurves.• Each consumer has aunique preference map.• As we move downwardalong an indifferencecurve, the marginal rateof substitution declines.
  • CHAPTER5CHAPTER537© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAppendix: Indifference Curves• Consumers will choosethe combination of X andY that maximizes totalutility.• Graphically, the consumerwill move along the budgetconstraint until the highestpossible indifference curveis reached.
  • CHAPTER5CHAPTER538© 2004 Prentice Hall Business Publishing© 2004 Prentice Hall Business Publishing Principles of Economics, 7/ePrinciples of Economics, 7/e Karl Case, Ray FairKarl Case, Ray FairAppendix: Indifference Curves• To obtain the demand curve for good X, we change the price of good Xand observe the change in the quantity of X demanded.