Download 3_Consumer_Theory

Introduction to Economics
Egor Sidorov
1. Consumer and utility
2. Cardinal utility theory
3. Ordinal utility theory
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Rational consumer model
─ Economics doesn’t analyze individual
preferences and tastes. It analyzes the individual
behavior aimed at satisfying needs.
─ Economics gives an answer to the question: How
should one act in the most rational manner?
─ Model of rational consumer describes the general
patterns of consumer behavior.
─ The aim of the rational consumer is to use limited
resources on the purchase of goods and services to
get maximum satisfaction, which, of course, is a
subjective phenomenon.
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─ Rationalism is not about the specific consumer
aims, but the way he reaches these aims.
Hours
Total utility of
Counterstrike
game
Additional
utility from
Counterstrike
game
Total utility of
Additional
reading a book utility from
reading a book
1 hr
☺☺☺
☺☺☺
☺☺
☺☺
2 hrs
☺☺☺☺☺
☺☺
☺☺☺
☺
3 hrs
☺☺☺☺☺☺
☺
☺☺☺
─ Rational consumer uses his recourses in a way that
additional utility from enjoying each of existing
alternatives is the same.
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Utility
─ Utility –is a measure of the relative satisfaction from
consumption of various goods and service
─ Cardinal utility theory – one can measure utility (e.g.
In USD – willingness to pay)
─ Ordinal utility theory – one can’t measure utility
precisely, however we can compare utilities together
vs.
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Utility contd.
─ The doctrine of utilitarianism saw the
maximization of utility as a moral criterion for
the organization of society.
Jeremy Bentham
─ society should aim to maximize the total utility of
individuals, aiming for "the greatest happiness for the
greatest number of people".
─ Subjective happiness – hard-to-formalize.
─ Objective happiness managed by the
professionals, state, etc.
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1. Consumer and utility
2. Cardinal utility theory
3. Ordinal utility theory
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Cardinal utility theory
Utility is the
function of
quantity of goods
consumed.
Number of
movies
Willingn
ess to
pay
Additional
utility
1 film
100 CZK
100
2 films
150 CZK
150 – 100 = 50
MU2 = TU2-TU1
3 films
150 CZK
150 – 150 = 0
4 films
140 CZK
140 – 150 = -10
TU (Total Utility)
MU (Marginal Utility)
Law of
Diminishing
Marginal
Utility
150
A
100
100
50
75
50
Mathematically
marginal utility is the
first derivation of
utility function
A
25
1
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Q
1
2
3
4
5
6
Q
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Law of Diminishing Marginal
Utility
─ „Marginal“ means „additional“.
─ Marginal utility is the change in utility obtained by
increasing use of good by unit (e.g. extra movie).
─ The highest additional utility is connected with
consumption of the firs unit. Every next unit brings
less satisfaction.
─ The total utility is therefore growing with every next
consumed unit of good at constantly declining growth
rate.
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Individual consumer surplus
─ Different consumers perceive utility differently.
─ Consumer surplus is the difference between the
willingness to pay for the good and actual
established market price.
Price and WTP (USD)
60
40
Price
E
20
1
2
3
4
Consumer surplus:
the total consumer
surplus USD 70 is
the sum of individual
consumer surpluses
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10
Rational consumer and marginal
utility equality principle
─ If pizza costs 5 times more than the cheeseburger,
one would buy pizza given that its marginal utility is
at least 5 times higher compared to cheeseburger.
MU
50 CZK
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=
MU
1O CZK
11
Utility maximization constraint
─ given limited budget, consumer facing the market
prices maximizes his utility if the MU per dollar
additionally spent on one good is equal to MU per
dollar additionally spent on any other good.
MU A MU B

 ...
PA
PB
─ In other words marginal utility generated by
spending the dollar should be equal for every good
in the consumer basket.
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Rational consumer
─ Individuals tend to be irrational, they make decisions
under pressure, in accordance with habits and
actual moods. None of us neither measures
marginal utility nor calculates optimal conditions.
─ Economists deal with the law of large numbers:
when the significant number of agents acts
consistently avoiding mistakes and consumer
behavior fluctuations the above mentioned
economic laws hold.
vs.
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Rational consumer and marginal
utility equality principle
─ If cheeseburger had higher marginal utility than
pizza, one could increase the total utility by
switching from pizza to buying cheeseburgers. This
would continue until marginal utility of cheeseburger
per money unit is equal to marginal utility of pizza
according to the law of diminishing marginal utility.
MU
50 CZK
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<
MU
1O CZK
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Why does supply curve has
down warding slope?
─ If price of cheeseburger goes up (ceteris paribus)
the MU to price ratio would be lower than in pizza’s.
In this respect one would reduce consumption of
pizza and therefore reach the equilibrium state. In
this respect increase in price involves decrease of
quantity demanded.
─ If MU is measured in money, then the marginal
utility curve is equal to demand curve.
MU
50 CZK
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>
MU
1O CZK
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Consumer budget
I = Px*Qx + Py*Qy
Budget equation:
300=50*Qp+10*Qh
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4
2
10
20
30
Budget line – depicts the
maximum affordable baskets of
goods given the fixed consumer
income.
1. Consumer and utility
2. Cardinal utility theory
3. Ordinal utility theory
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Ordinal utility: indifference
analysis
─ The consumer is capable of defining which
consumer basket of goods is more preferable.
However he cannot determine its absolute utility
as in case of cardinal theory.
TU Celkový užitekTU (total utility)
TU1
A
is the
indifference curve
with the level of
total utility equal to
TU 1
TU1
A
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Ordinal utility: indifference
analysis
─ All goods’ combinations on A
curve have the same utility:
=
+
+
─ The consumer chooses more
goods over less.
─ The set of indifference curves
is called an indifference map.
6
4
C
B
2
A
10
20
30
Ordinal utility: substitution rate
─ The more scarce good has
higher relative rate of
substitution. Its marginal
utility grows compared to
marginal utility of the more
abundant good:
compare 4:5
vs ½:10.
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4
4
C
2
B
5
0,5
10
10
20
A
30
Ordinal utility: rational
consumer behaviour
─ The consumer achieves
optimal state in the point
where the budget line is
actually a tangent line to the
highest possible indifference
curve, where the substitution
rate is equal to its slope.
─ Indifference curve exists in
each point of the map.
─ The consumer chooses the E
set of goods on the B curve:
3x
a 15x
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E
4
C
B
2
A
10
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Demand curve
─ If the cheeseburger price
goes up (e.g. by 50 percent)
ceteris paribus one would
reduce its consumption and
would move to the lower
indifference curve with a
lower utility level.
─ Again the price growth
causes the decrease of
quantity demanded.
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E
4
C
B
2
A
10
20
30
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Thank you for attention!
Sources:
SAMUELSON, P. A., NORDHAUS, W. D. Ekonomie 18. vydání. Praha:
Svoboda, 2005.
KRAFT, J., RITSCHELOVÁ, I. Ekonomie pro environmentální management.
Ústí n. L.: UJEP, 2003.
MCDOUGAL LITTELL. Economics: Concept and Choices. Canada:
McDougal Littell, 2008.
HOŘEJŠÍ, B. et al. Mikroekonomie. 4. rozšířené vydání. Praha: Management
press, 2006.