This document discusses consumer behavior and the price system. It introduces key concepts such as indifference curves, the budget line, utility, and elasticity. The key points are: 1. Consumers seek to maximize utility subject to a budget constraint. Indifference curves and budget lines are used to analyze consumer choice. 2. The law of diminishing marginal utility states that as consumption of a good increases, the marginal utility from each additional unit decreases. 3. Consumers seek to obtain the highest level of satisfaction or utility possible given their budget. Equilibrium occurs where the indifference curve is tangent to the budget line. 4. Elasticity measures the responsiveness of quantity demanded to price changes

1. ECA III – THE PRICE SYSTEM
LECTURE III
THEORY OF THE CONSUMER

2. I. ASSUMPTIONS OF CONSUMER BEHAVIOR
• Individual preferences are known (or
knowable)
• These preferences can be quantified & then
ranked [Independent of Market Prices
• These rankings are consistent
• Consumers wish to have more of something
than less of it (Generally Speaking)

3. II. Indifference Curves (Maps) [Schedules]
(Within a Two – Good World)
A.
Increasing Utility
Good Y
Ay A C
5
4
3
By B 2
1
Ax Bx
Good X

4. B. Characteristics
1. Downward sloping to the right
2. Non – Intersecting
3. Convex to the origin
III Relations among Products
A. Substitutes: (Functionally similar) Increased
consumption of “A” causes decreased
consumption of “B”
B. Complements: (Functionally related) Increase
Consumption of “A” causes increased
consumption of “B”

5. IV. Utility
A. Utility: Expected satisfaction from a good
- Utility may be misleading in that it is not always
utilitarian (objective) 2cars > 1 Car (Obviously)
- Utility also includes more subjective
considerations such as personal history (i.e.
could not buy the sports car at 18 (no money).
Will get it now (have money) even though don’t
need really need it (need storage more)
Wants can be Temporal (Mid-life crisis). Also satisfaction is
subjective – i.e. music taste

6. B. Total Utility: Amount of satisfaction derived
from (Total) Entire Consumption of good.
C. Marginal Utility: Amount of satisfaction
derived from consuming the last unit of a
good.

7. D. Law of Diminishing Marginal Utility: The
- MU of a good decreases as more of that
good is consumed, all else constant, within the
time period.
- This doesn’t mean that we don’t like the
additional unit, rather that we won’t like them
as much
E. Total VS Marginal Utility
- As Consumption (X)↑ → MU (X)↓
- As long as MU (X) = + => Total Utility still
rises.

8. F. The greater a good’s MU, the more the
consumers will pay for it.
1. Since MU ↓ as Consumption↑
→ Consumers will pay for it.
Therefore, as consumers spend more in a given
store MU ↓ & must be induced to buy more
Savings passes on all purchases in one day.

9. 2. If all else is constant, consumers will only buy more
if the price falls.
Price
Demand
Quantity
As Quantity Consumed ↑ → MU↓
Quantity Demanded ↑ only if Price ↓

10. G. Decisions about Work
H1: MU-I > MU-L → WORK MORE HOURS
H2: MU-L > MU-I → WORK FEWER HOURS
H*: MU-I = MU-L → EQUILIBRIUM
As Hours Worked ↑ MU Income ↓ & MU Leisure ↑

11. IV. Budget Line
A. This represents consumers’ income
B. Shows the quantities of Goods that can be
purchases at all levels of income
C. Graphically:
AB : Budget Line
A
Real Income = OA – or – OB (or any combination)
Good Y
Ey
Indifference Curves
0
Ex B Good X

12. D. Consumer Satisfaction is maximized at
Any Other Good “i”
E. Changes in the Budget Line (Constraint)
A Change in Income Shifts the Budget Line
AB → CD: ↑ Income
CD → AB: ↓ Income

13. A change in the Price of a Good changes the slope of the Budget
Line
If AB ∆ to AC → Price of “X” ↓ Quantity Demanded ↑
If AB ∆ to AD → Same on a Larger Scale
If AD ∆ to AC → Price of “X” ↑ Quantity Demanded ↓

14. Q1. If AB ∆s to CD can there be a ∆ in Price?
Q2. What would happen to a Consumer’s Budget Line if he
received a promotion during Inflation?

15. V. Consumer Equilibrium .
[At the highest point of tangency of the Indifference & Budget Line]
At Income Level AB
Oa + Ob
At Income Level CD
Oc + Od
0

16. VI. Elasticity
A. Elasticity is the responsiveness of quantity
to changes in price
B. Categories
- Elastic (E>1): Very Responsive
- Inelastic (E<1): Not Responsive
- Unitary Elasticity: % ∆ QD = %∆P

17. ELASTIC
Price
E>1
P1 ∆P < ∆Q
(P1-P2) < (Q2-Q1)
∆P
P2
∆Q
D
Q1 Q2
Quantity

18. INELASTIC
Price
E<1
P1 ∆P > ∆Q
(P1-P2) > (Q2-Q1)
P2
D
Q1 Q2 Quantity

19. UNITARY ELASTICITY
Price
E=1
∆P = ∆Q
P1 (P1-P2)=(Q2-Q1)
∆P
P2
∆Q
D
Q1 Q2 Quantity

20. C. Determinants
1. Whether the good is a luxury or Necessity
- Necessity = Inelastic
- Luxury = Elastic
2. The Availability of Substitutes
- More available = Elastic
- Less available = Inelastic
3. % of Consumers Budget
- Larger % = Elastic
- Smaller % = Inelastic

21. Elasticity & Money Outlays
I. Elastic (E>1)
↑P →↓TR
↓P →↑TRI
II. Inelastic (E<1)
↑P →↑TR
↓P →↓TRI
III. Unitary Elasticity (E=1)
↓↑P → No Change in TR

22. D. Other Elasticities
Income Elasticity: Responsiveness of Quantity
Demand of a goo to changes in Income.
a) Normal Good: Demand Increase as Income
Increases
* Income Elasticity = “+”
b) Inferior Good: Demand Decreases as Income
Increases
*Income Elasticity = “-” (Discounted Stores)