AG ECON 200

1
AG ECON 200

• PART 3 CONSUMER DECISIONS
• WK 3-4 INDIFFERENCE CURVES AND BUDGET LINES

2
Review
WK 3-3 CONSUMER BEHAVIOR UTILITY
A. Rational Consumers Buy Things Based On Their
Utility
B. Utility Is A Ordinal, Subjective Measure Of
Satisfaction Based OnThe Person, Item, Place And
Time.
C. Additional Units Are Worth Less Principle Of
Dim Marginal Utility
D. Rational Consumers Will Allocate Limited
Resources Among Choices         Based On The
Highest Marginal Utility
3
Part 3 Consumer Decisions

• Wk 3-3 Cons Behavior Utility Of 1 Good
• WK 3-4 ISO-UTIL CURVES BUGET LINES
• Wk 3-5 Individual Market Demand
• Wk 4-1 Change In Demand Quant Demanded
• Wk 4-2 Price Elasticity Of Demand
• Wk 4-3 Income Cross Elasticity
• Wk 4-4 Consumer Surplus Aggregate Demand
• Wk 4-5 Midterm 1

4
LESSON OBJECTIVES
WK 3-4 ISO-UTIL CURVES BUGET LINES

• AFTER COMPLETING THIS LESSON THE STUDENT SHOULD
  BE ABLE TO

• Explain an indifference curve map explain the
  movement along and between indifference curves.
• b. Define the budget constraint by formula or
  graph and be able to discuss the two factors
  which determine its position and slope.
• c. Find consumer optimum by MRCS or graph
• d. Demonstrate how changes in prices and/or
  income affect consumer optimum.

5
I. REVIEW OF SINGLE ITEM UTILITY
WK 3-4 ISO-UTIL CURVES BUGET LINES
A. UTILITY B. MARGINAL UTILITY C. PRIN OF
DIMINISHING MARGINAL UTILITY D. UTILITY
OPTIMIZATION OF ONE GOODS INDIVIDUALLY
SATISFACTION
Added Satisfaction From Consuming One More Unit
As You Consume More, You Want Less
Consume Until Added Benefit Added Cost
Marginal (Added)Utility Value
Marginal(Added)Cost
6
D. Allocation Of Resources Between Two Individual
GoodS Based On Utility
Wk 3-4 Iso-util Curves Buget Lines
PersonalFinance
Micro

• 1. Economic Is The _____ Science Of ___________
  Scarce __________ To Maximize _______

Social
Allocating
Resources
Utility
2. Life Uses More Than One _________ So We Must
Allocate Our ___________________ Among Several
____________________
Macro
Good
Scare Resources
Goods And Services
7
Good A 1 2 3 4 5
6 Util/1cst 2.50 2.00 1.01 0.50 0.25
-0.25
Wk 3-4 Iso-util Curves Buget Lines
3. Optimum Allocation Of Resources Between Two
Individual Goods Based On Utility In A Table
3
5
7
Good B 1 2 3 4 5
6 Util/1cst 3.50 3.00 2.25 1.50 0.90
0.75
1
2
4
6
Budget 5
1st PURC 2nd PURC 3rd PURC 4th PURCH 5th
PURCH
Wid B-1
Wid B-2
Wid A-1
Widb-3
Wid A-2
F. Where Do You Put Your Money?
The Widget With Next Highest Utility Ratio
Unlimited Budget
6th PURCH
7th PURCH
8th PURCH
G. How Much Money Do You Spend On Widgets?
As Long As Utility / Cost Ratio Is Above One
8
II. Utility For Two Goods Graphically
Explain An Indifference Curve Map Explain
Movement Along Between Indiff Curves.
1
Obj

• Indifference Curve Approach. Iso-utility Curves
  Combinations That I Want
• A. Questions
• 1. Does It Seem Logical That A Person
  Would Consider The Marginal Utility Of An Item In
  Isolation?
• 2. Would The Marginal Utility Of Pop Be
  Related To The Amount Of Potato Chips That A
  Person Consumed?
• 3. Would It Seem Reasonable To Assume
  That Higher Total Utility Is Preferable To A
  Lower Total Utility?

No
Yes
Yes
9
B. Concept
Explain An Indifference Curve Map Explain
Movement Along Between Indiff Curves.
1
Obj
1. Instead Of Looking The _____ Of Two Goods
__________, We Going To Look At The _____ Of A
____________ Of Two Goods Consumed At The Same
Time.
Utility
Utility
Individually
Combination
2. It Is Assumed That Different Combinations Of
Two Goods Can Give Us The Same ______. For
Example, We Would Get The _____ Utility From 2
Whoppers And 1 Fry Or From 1 Whopper 3 Fries.
Utility
Same
10
Explain An Indifference Curve Map Explain
Movement Along Between Indiff Curves.
1
Obj
3. Since Both Combinations Give Us The
__________, We Are ________About Which
Combination We Consume, Hence The Name
Indifference Curve Approach To Utility Of Two
Goods Consumed Together ISO Means Equal, So
The ________ Curves Are Also Called Iso-
_____Curves
Same Utility
Indifferent
Indifferent
Utility
11
Explain An Indifference Curve Map Explain
Movement Along Between Indiff Curves.
1
OBJ

• Table Combination Of Two Goods That Produce The
  Same Total Utility

100
100
100
Total Utility
100
100
100
Good 1 PORK
14
5
10
7
25
19
Good 2 BEEF
5
6
8
11
15
20
Economic Convention Place The Good Being Replaced
(Good 1) On The _________ Axis And The Good Beind
Added (Good 2) On The __________ Axis
Y1 VERT
Y2 HORT
12
Explain an indifference curve map explain
movement along between indiff curves.
1
OBJ
SINCE ALL POINTS HAVE A UTILITY OF 100, WE ARE
INDIFFERENT AS TO WHAT COMBINATION GD 1 GD 2 WE
PURCHASE
(5,25)
(6,19)
GD1 PORK
(8,14)
(11,10)
(15,7)
(20,5)
GD2 BEEF
13
C. Indifference (Iso-utility ) Curve
Characteristics
Explain An Indifference Curve Map Explain
Movement Along Between Indiff Curves.
1
OBJ
1. Slope __________ 2. Relationship
________     a.  _____ consumption gt _____ marg
utility     b. _____ consumption gt ______ marg
utility 3. Shape _______
NEGATIVE
INVERSE
MORE
LESS
LESS
MORE
CURVE
4. Each indifference curve represents a unique
level of ________, there are an ________ number
of utility curves.
UTILITY
INFINITE
5. Higher Curves Mean Higher
UTILITY
6. Using More Moves To A Higher
LEVEL
14
Iso-Utility Map
Explain An Indifference Curve Map Explain
Movement Along Between Indiff Curves.
1
Obj
Utility Surface
Going Up To Higher Iso-utility Line Represents A
Higher Standard Of Living
7. Utility Surface A Three Dimensional
Representation Of The Utility Gained By Consuming
Two Goods Simultaneously
8. Iso-utility Map A Two Dimensional Map Of The
Utility Contours
15
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
Gd Y1Pork
9. Indifference Curvecontour Lines That
Indicates The Same Utility From Any Combination
Of Good Y1 (Pork) Good Y2 (Beef)
A
Y1
Higher Util Curves Represent A Higher Std Of
Living
B
Y2
Y22
Y21
Gd Y2 Beef
16
IV. Budget Line (Combinations That I Can Afford)
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj

• A. Gross Pay - Taxes Take Home Pay The Budget
  That I Have To Spend On Two Goods

B. Formula Budget (Quant Of Good Y Price
Good Y) (Quant Of Good X Price Good X)
C. What I Can Afford Depends On Two Things
1. Income
2. Price Of The Goods
17
B. Budget Line Table Afford
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
Good Y2
Good Y1
Price
Quant
Budget
Price
Quant
1.25
.50
10
5.00
4
2.50
.50
5
Inc Dec
1.25
2
5.00
.50
2.50
10
2
Price Chg
Y1 Pork
10
Y1 Pork
PriceChangesSwings BudgetLine
Income Changes Shifts Budget LineDecr Inc gt
Shift Lf
B1
10
5
B2
Y2Beef
Y2Beef
4
2
4
2
18
B. Budget Line Changes
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
Then The Budget Line
If
Income Increases
Up
Shifts
Down
Income Decreases
Shifts
Swings
Left
Price Of Y1 Increases
Swings
Price Of Y1 Decreases
Right
Price Of Y2 Increases
Swings
Down
Swings
Price Of Y2 Decreases
Up
19
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
B1
Gd Y1Pork
F. Iso Utility Budget Line
Budget Line What I Can Afford
Optimum?
Consumer OptimumBudget LineTangent
ToIso-utility Curve
No
Y1
Optimum?
Iso-utilityWhat I Want
YES
Optimum?
No
Gd Y2 Beef
Y2
B1
20
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
B2
G. Income Increase
Gd Y1Pork
Consumer Optimum At Higher Pt Higher Std Of
Living Because Of More Money To Spend Income
Effect
B1
Y1I2P1
Buy More Of Both
Y1I1P1
Y1I1P1
Y2I2P1
Gd Y2 Beef
21
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
B1
Price Decr For Beef
Buy More Beef
Budget Swings Rt
Gd Y1Pork
1. Lower Beef Price Means You Can Buy More Of It
With Your Budget. 2. You Will Also Buy More
Because It Is Relatively Cheaper. 3. This Is The
Substituion Effect. 4. You Will Be At A Higher
Level Of Utility.I.E. Higher Standard Of Living
Y1I1P1
Y1I1P2
Buy More Of One Whose Price Decreased
B1
Y2I1P2
Gd Y2 Beef
Y1I1P1
22
Determine Impact Of Changes In Budgets Prices
On Iso-utility Budget Lines.
Obj
2
Budget
Shifts
Up
Budget
Swings
Budget
Shifts
Down
Both Prices Incr
Lower Cons Optimum
Both Prices Decr
Budget
Shifts
Up
Higher Cons Optimum
23
Income And Substitution Effects
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
24
III. Marginal Rate Of Substitution
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
A. As We Move Along An _________ Curve, The
_________ Utility Is ___________But The Amount
Of Each Good Is ___________. As The Amount Of
One Good _____________, The Other IS
_______________
Utility
Total
Constant
Changing
Increases
Decreasing
B The Marginal Rate Of Substitution Is The Rate
At Which A ____________ Is Willing To Substitute
One ______ For Another ______And Still Maintain
The ________Total Utility.
Consumer
Good
Good
Same
C. What You Are Willing To Give Up (Opportunity
Cost) To Get More Of Another Good, Still
Maintain The Same Total UTILITY
25
E. Table Format
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
0
1
Obj
Marg RateOf Sub
Chg In Gd 1
Chg In Gd 2
Inv PriceRatio
Gd 1
Gd 2
Chg In Gd 1Chg In Gd2
Price Gd 2Price Gd1
Gd1 Price 1.00
2.50
Gd2 Price 2.50
XX
XX
XX
1.00
05
25
2.5
-6/1 -6.0
1
-6
19
06
2.5
2
-5/2 -2.5
-5
14
08
2.5
-4
3
-4/3 -1.33
10
11
4
2.5
-3/4 -0.75
-3
07
15
2.5
05
-2
20
5
-2/5 -0.40
Marg Rate Of Sub ? G1/ ?G2
Inverse Price Ratio Price Of G2/Price Of G1
Opt Pt Where MRCS Is Closest To Inv Price Ratio
26
Marg Rate Of Sub Inverse Of Marg Utility Ratio
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj

• 1. (Chg In Good Y Marg Util Of Good Y) (Chg
  In Good X Marg Util Of Good X)
• 2. Dividing Through By (1) Chg In Good X, (2)
  Marg Util Of Good Y Results In
• Chg In Good Y Marg Untility Of Good X
• Chg In Good X Marg Untility Of Good Y
• As We Decrease Amt Of Y Good, Its Marg
  Untility Increases
• As We Increase Amt Of X Good, Its Marg
  Untility Decreases

27
Explain An Indifference Curve Map Movement
Along Between Indiff Curves
1
Obj
Since All Points Have A Utility Of 100, We Are
Indifferent As To What Combination We Purchase
(5,25)
-6
(6,19)
1
(8,14)
-4
(11,10)
(15,7)
3
(20,5)
28
Wk 3-4 Iso-util Curves Buget Lines
Summary
A. ______________ Curves Show The _______________
Of Two _______________ That Give The Same
___________________
Iso-utility
Goods
Combination
Satisfaction (Utility)
B. The ______________ Line Show The
______________ Of Two _________________ That Can
Be Bought With A Given Amount Of ________________
Budget
Combination
Goods
Money
C. ______________ Consumption Is Where The
_________________ Curve Is _________ To The
__________________ Line OR
Optimum
Iso-utility
Tangent
Budget
29
Wk 3-4 Iso-util Curves Buget Lines
D. _______________________________ Equal
_______________ Price Ratio.
Margina Rate Of Substitution
Inverse
E. Changes In _____________ Will Cause The Budget
Line To _______________
F. Changes In _____________ Will Cause The Budget
Line To _______________
Income
Prices
Shift
Rotate
30
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• CONSUMER DEMAND