YH

Consumers and Incentives

Three Key Ingredients in Consumer Choice

  • Important factors impacting consumer decisions:
    • What You Like: Personal tastes and preferences.
    • Prices: The cost of goods and services.
    • How Much Money You Have to Spend: Financial resources available.
  • All three ingredients lead to powerful implications concerning consumer behavior.

What You Like: Tastes and Preferences

  • Understanding Preferences:
    • Consumers exhibit diverse preferences; everyone has unique likes and dislikes.
    • Common Assumption:
      • Consumers aim for the "biggest bang for their buck"—maximizing value received from purchases.
    • Preferences are revealed through actual purchasing choices.

Prices of Goods and Services

  • Price Characteristics:
    • Prices are considered fixed within this framework—no negotiation involved.
    • Consumers can buy an unlimited quantity without affecting the price due to demand increases.

How Much Money You Have to Spend: The Budget Set

  • Budget Limits:
    • Consumers operate under constraints:
      • No mechanisms for saving or borrowing; spending is the only option.
      • Purchases are represented as discrete choices (whole units of goods).

Visualizing the Budget Set

  • Budget Set vs. Budget Constraint:
    • The budget set includes all possible bundles on and inside the budget line indicating affordable options.
    • Bundles outside the budget line are unaffordable.

Opportunity Cost and the Budget Line

  • Understanding Opportunity Cost:
    • Opportunity cost reflects the value of what is foregone when making a choice.
    • For example, choosing to buy jeans over sweaters entails the loss of potential benefits from not buying sweaters.
    • The expression for calculating opportunity costs:
      \text{Loss in Opportunity Cost} = \frac{\text{jeans}}{\text{sweaters}}

The Negative Slope Represents the Trade-Off the Consumer Faces

  • Implication of Trade-Offs:
    • The negative slope of the budget line indicates that an increase in one good requires a decrease in another, embodying the trade-off principle.
    • Example equations for calculating loss in opportunity cost:
    • Loss in opportunity cost of sweaters for jeans equals \frac{\text{jeans gained}}{\text{sweaters lost}} = 6 jeans / 0.5 sweaters = 12 sweaters.

Would You Take the Jag?

  • Thought Experiment Example:
    • Scenario: A luxury car (Jaguar) offered for free.
    • Key Question: Would you still prefer the same amount of money instead? Reflects choices based on value perception.

The More You Have, the Less You Want

  • Impact of Marginal Benefit:
    • With more consumption, the marginal benefit derived from additional units typically decreases.
    • Hypothetical scenario demonstrating diminishing marginal benefit:
    • If one unit of a product yields a high initial benefit, the subsequent units tend to provide lower incremental benefits.

Connecting Diminishing Marginal Benefit to Demand Curve

  • Demand Curve Characteristics:
    • Negative slopes in demand curves result from the diminishing marginal utility.
    • As additional units provide less utility, the willingness to pay also declines.

Getting the Most Bang for Your Buck

  • Buyer’s Optimization Problem with Fixed Budget:
  • Tabulation of total benefits for sweaters and jeans:
    • Sweaters ($25), Jeans ($50):
    • Example: Pricing $25 for sweaters and $50 for jeans demonstrates price allocation through marginal benefits.

Tracing Demand from Optimal Choices

  • Demand Curve Construction:
    • Illustrates points on the demand curve based on pricing and quantity choices:
    • Example: Quantity demanded for jeans priced at $50 is 3.

Consumer Equilibrium, Explained

  • Equilibrium Condition Simplification:
    • Condition holds when Marginal Benefit per dollar equals price per good (e.g., jeans priced at $50).

Budget Constraints on the Move: When Sweaters Get Pricey

  • Effects of Price Changes on Consumer Choices:
    • Discusses implications when the cost of merchandise, such as sweaters, doubles.

What Happens When Prices Move?

  • Consumer Reaction to Price Changes:
    • Explores shifts in demand as prices vary (Example: price of jeans rises from $50 to $75).

From the Buyer’s Problem to the Demand Curve

  • Illustrating Demand Curve Relationships:
    • Analysis of demand shifts in relation to price changes and consumer surplus demonstration.

Consumer Surplus

  • Definition of Consumer Surplus:
    • Concept defined as the difference between what consumers are willing to pay and what they actually pay for goods.

Computing Consumer Surplus Using Rectangular Areas In a Graph

  • Graphical Representation:
    • Example graph illustrates total consumer surplus visually alongside price metrics.

Market-Wide Consumer Surplus

  • Calculation of Market Consumer Surplus:
    • Example calculation yielding a total consumer surplus of $2.25 billion illustrated through triangle area formula $ ext{Base} \times ext{Height}/2$.

Elasticity of Demand

  • Understanding Pricing Sensitivity:
  • Differentiates why some goods exhibit elastic demand (e.g., theater tickets) while others do not (e.g., last-minute flights).

Cross-Price Elasticity of Demand

  • Evaluating Market Changes:
    • Definition: Analyzes consumer behavior changes concerning price adjustments in complementary and substitute goods.

Income Elasticity of Demand

  • Consumer Response to Income Changes:
    • Explores how quantity demanded shifts with variations in consumer income levels.

Determinants of Price Elasticity of Demand

  • Key Influencing Factors:
    • Closeness of substitutes, budget share of goods, and available time for adjustments dictate elasticity degrees.

Visualizing Elasticity Along a Linear Demand Curve

  • Density Variation in Demand Elasticity:
    • Examines how elasticity varies throughout the segments of a linear demand curve, indicating areas of elasticity and inelasticity.