Chapter 4 Individual Behavior

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Chapter 4Individual Behavior

• Theory of consumer choice explains how
  consumption depends on prices, income and
  preferences.

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De gustibus non disputandum est

• Preferences are taken as given, except for four
  assumptions of rationality
• 1. Completeness A ? B or B ? A or A B.
• 2. Nonsatiability more ? less
• 3. Transitivity If A ? B and B ? C, then A ? C.

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Diminishing marginal rate of substitution (MRS)

• You are less willing to trade for something you
  have more of.
• The first unit goes to highest valued use.
• The next unit goes to next highest valued use.
• The first unit is of greater value than the
  second.

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Indifference Curves

• All bundles that are considered equivalent
• Completeness implies ICs fill the plane.
• More ? less implies negative slope.
• C ? B ? A

X
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• Transitivity implies they do not cross.
• A C and B C so A B.
• But A ? B, more of X and Y.

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Constraints
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Budget Constraint


Y
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Changes in income M
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Increase in PY
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Consumer Equilibrium
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Equilibrium prices Reflect Preferences
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Excel Workbook

• Use this workbook to practice calculating the
  slope and axis of the budget line.

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Deriving Consumer Demand

• Y is a composite good
• Holding PY constant, at price PX, X(PX) is
  chosen.
• If PX increases to PX, then X(PX) is chosen.

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Consumer Demand
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Law of Demand?

• If X is a normal good, then demand is negatively
  sloped.
• If X is an inferior good, demand is negatively
  sloped as long as PXX is not too great a
  proportion of M.

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Overtime or Wage Increase?
Income
B
C
A
LA
LB
LC
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leisure