ECN104 Lecture 5

Consumer Behaviour

The Buyer's Problem

Understanding consumer behaviour begins with analyzing the buyer's problem, which consists of three fundamental components: preferences, prices, and budget constraints.

• Preferences: What you like, determined by your tastes and preferences.

• Prices: The cost of goods and services, assumed to be fixed and non-negotiable in basic models.

• Budget: The amount of money available for spending, with the assumption that consumers neither save nor borrow, but only purchase whole units.

An optimizing buyer makes decisions at the margin, meaning choices are made by comparing the additional benefit and cost of consuming one more unit of a good or service.

• Marginal Analysis: Consumers weigh the marginal benefit (MB) against the marginal cost (MC) for each additional unit.

• Demand Curve: An individual's demand curve reflects both the ability and willingness to pay for a good or service.

Consumer Surplus

Consumer surplus is a key concept in microeconomics, representing the difference between what a buyer is willing to pay and what they actually pay.

• Definition: Consumer surplus is the area between the demand curve and the price line, up to the quantity purchased.

• Significance: It is a meaningful measure of changes in consumer well-being.

Why Economics is Called the “Dismal Science”

The term “dismal science” refers to the perceived pessimism in economics, often attributed to its focus on scarcity, trade-offs, and finite resources.

Elasticity

Elasticity measures how responsive one variable is to changes in another variable, such as how quantity demanded responds to price changes.

• Price Elasticity of Demand: Measures the percentage change in quantity demanded resulting from a percentage change in price.

Consumers and Incentives

The Demand Curve and Its Slope

The demand curve typically has a negative slope, indicating that as price decreases, quantity demanded increases.

• Example Equation: $Q_d = 350 - 50P$

• Inverse Demand: $P = 7 - Q_d/50$

This negative relationship is fundamental to the law of demand.

Demand Schedule Table

Price (per gallon)	Quantity Demanded (gallons/year)
7	0
6	50
5	100
4	150
3	200
2	250
1	300

What You Like: Tastes and Preferences

Role of Preferences in Consumer Choice

Consumers have diverse tastes and preferences, but two assumptions are commonly made:

• All consumers seek the “biggest bang for their buck,” aiming to maximize utility given their budget.

• Actual purchases reflect underlying tastes and preferences.

Prices of Goods and Services

Assumptions About Prices

In basic microeconomic models, prices are assumed to be:

• Fixed, with no negotiation.

• Unaffected by individual purchases, meaning consumers can buy as much as they want without influencing market price.

How Much Money You Have to Spend: The Budget Set

Budget Constraints and Consumer Choice

The budget set represents all possible combinations of goods a consumer can afford, given their income and the prices of goods.

• No saving or borrowing is allowed; only current income is spent.

• Purchases are made in whole units, even though the budget line is drawn as a continuous line for analytical convenience.

Budget Constraint Equation

Given jeans cost $50 each, sweaters cost $25 each, and the consumer has $300 to spend, the budget constraint is:

• $50j + 25s = 300$

Budget Line Table

Bundle	Quantity of Sweaters	Quantity of Jeans
A	12	0
B	2	4
C	6	6
D	0	6

Graphing the Budget Set

To graph the budget set, solve for one good in terms of the other:

• $50j + 25s = 300$

• $s = (300 - 50j)/25$

• $s = 12 - 2j$

More generally, for two goods X and Y:

• If $P_y Q_y + P_x Q_x = B$, then $Q_y = B/P_y - (P_x/P_y) Q_x$

Interpreting the Slope of the Budget Line

The slope of the budget line represents the rate at which one good can be traded for another, given their prices. In this example, the slope is -2, meaning each additional jean purchased requires giving up 2 sweaters.

Opportunity Cost

Opportunity cost is the value of the next best alternative forgone when making a choice.

• Opportunity cost of jeans: $\text{Loss in sweaters} / \text{Gain in jeans} = 2/1$

• Opportunity cost of sweaters: $\text{Loss in jeans} / \text{Gain in sweaters} = 1/2$

• General formula: $\text{Opportunity cost of something} = \frac{\text{Loss of units of other stuff}}{\text{Gain in units of something}}$

Summary Table: Four Bundles on the Budget Constraint

Bundle	Quantity of Sweaters	Quantity of Jeans
A	12	0
B	2	4
C	6	6
D	0	6

Key Concepts and Applications

• Consumer behaviour is driven by preferences, prices, and budget constraints.

• Consumer surplus measures the benefit consumers receive from paying less than their maximum willingness to pay.

• Budget constraints define the feasible set of consumption choices.

• Opportunity cost quantifies trade-offs in consumption decisions.

• Elasticity is crucial for understanding how changes in price or income affect demand.

Additional info: The notes provide foundational concepts for microeconomic analysis, including graphical and algebraic representations of consumer choice and budget constraints. These principles are essential for further study of demand, utility, and market equilibrium.