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MANAGERIAL
th
ECONOMICS 11 Edition
By
Mark Hirschey
Consumer Demand
Chapter 4
Chapter 4
OVERVIEW
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Utility Theory
Indifference Curves
Budget Constraints
Individual Demand
Demand Curves and Consumer Surplus
Consumer Choice
Optimal Consumption
Chapter 4
KEY CONCEPTS
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utility
nonsatiation principle
indifference
ordinal utility
cardinal utility
utility function
utils
market baskets
marginal utility
law of diminishing marginal utility
indifference curves
substitutes
complements
perfect substitutes
perfect complements
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budget constraint
income effect
substitution effect
price-consumption curve
income-consumption curve
Engle curve
normal goods
inferior goods
consumer surplus
two-part pricing
bundle pricing
optimal market basket
revealed preference
marginal rate of substitution
consumption path
Utility Theory
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Assumptions About Consumer Preferences
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Utility Functions
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Descriptive statement relates well-being and
consumption.
Marginal Utility
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More is better.
Consumers can rank preferences.
Consumers ran-order desirability of products.
Added benefit is focus of consumers.
Law of Diminishing Marginal Utility
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Marginal utility eventually declines for everything.
Indifference Curves
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Basic Characteristics of Indifference
Curves
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Higher indifference curves are better.
Indifference curves do not intersect.
Indifference curves slope downward.
Indifference curves are concave to origin.
Perfect Substitutes and Perfect
Complements
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Perfect substitutes satisfy the same need.
Perfect complements are consumed together.
Budget Constraints
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Basic Characteristics of Budget Constraints
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Effects of Changing Income and Changing
Prices
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Shows affordable combinations of X and Y.
Slope of –PX/PY reflects relative prices.
Budget increase causes parallel outward shift.
Budget decrease causes parallel inward shift.
Income and Substitution Effects
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Income (substitution) effect is change in
overall (relative) consumption.
Individual Demand
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Price-consumption Curve
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Income-consumption Curve
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Shows how consumption is affected by price changes
(movement along demand curve).
Shows how consumption is affected by income
changes (shifts from one demand curve to another).
Engle Curves
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Plot between income and quantity consumed.
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Consumption of normal goods rises with income.
Consumption of inferior goods falls with income (rare).
Demand Curves and Consumer
Surplus
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Graphing the Demand Curve
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Consumer Surplus
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Value received above amount paid.
Consumer Surplus and Two-Part Pricing: An
Illustration
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Demand curves always slope downward.
Membership fees and user fees extract consumer
surplus for the seller.
Consumer Surplus and Bundle Pricing
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Bundle pricing extracts consumer surplus for sellers.
Consumer Choice
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Marginal Utility and Consumer Choice
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Optimal consumption maximizes utility.
Optimal consumption reflects marginal utility
(benefits) and marginal costs.
Revealed Preference
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Documented desire.
Buyer decisions can be used to infer
consumer preferences.
Optimal Consumption
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Marginal Rate of Substitution (MRS)
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MRSXY = -MUX/MUY and equals indifference
curve slope.
MRSXY shows tradeoff in the amount of X and
Y consumed, holding utility constant.
MRSXY diminishes as amount of substitution of
X for Y increases.
Utility Maximization
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Optimality requires PX/PY = MUX/MUY.
Optimality requires MUX/PX = MUY/PY.