Principles of Microeconomics Chapter 6: Household Behavior and Consumer Choice

Perfect Knowledge: Households possess knowledge of qualities and prices of all market goods. Firms have all information regarding wage rates, capital costs, technology, and output prices.
Perfect Competition: An industry structure with many small firms producing identical products. No single firm has control over pricing.

Homogeneous Products: Products are indistinguishable and identical to one another.

Households demand goods in output markets and supply labor and capital in input markets.

Household Choice in Output Markets: Explain the origin of the budget constraint and its impact on household demand.
The Basis of Choice: Utility: Understand the utility-maximizing rule in household product selection.
Income and Substitution Effects: Describe the effects of a decrease in food prices.
Household Choice in Input Markets: Discuss factors influencing labor supply and savings.
Appendix: Indifference Curves: Understand the derivation of the demand curve from indifference curves and budget constraints.

Households make three primary decisions: How much of each product to demand, how much labor to supply, and how much to spend now vs. save for future consumption.

Price of the Product: Direct relationship to quantity demanded.
Household Income: Available income influences demand levels.
Accumulated Wealth: Past savings alter current consumption ability.
Prices of Other Products: Substitution effects based on relative pricing.
Tastes and Preferences: Individual consumer preferences shape demand.
Expectations about Future: Anticipations regarding income, wealth, and future pricing.

Budget Constraint: Limits on household choices determined by income, wealth, and prices.
Choice Set (Opportunity Set): Options defined and limited by the budget constraint.

Real Income: The opportunities to purchase real goods and services influenced by prices and money income.

Utility: Satisfaction a product provides.
Law of Diminishing Marginal Utility: The additional satisfaction from consuming more of a good decreases as consumption increases.

Marginal and Total Utility

Marginal Utility (MU): Additional satisfaction gained by consuming one more unit of a good.
Total Utility: Overall satisfaction derived from consumption.

Utility-Maximizing Rule: Consumers spread expenditures until the ratio of marginal utility derived from the last unit of good X to its price equals that for good Y.

A concept illustrating that items of higher utility may have lower market value compared to less useful goods with high exchange value.

Income Effect: Change in consumption due to improved well-being from a price decline.
Substitution Effect: Change in consumption stemming from a product becoming relatively cheaper, leading consumers to favor it over others.

Households must decide whether to work, the amount to work, and the type of job to take.

Choosing more leisure requires reallocating time, where everyday leisure hours equate to equivalent lost wages. Wage rates represent the price of leisure.

Labor Supply Curve: Illustrates how much labor households supply at varying wage rates, influenced by substitution and income effects.

Two Labor Supply Curve Scenarios

Upward Sloping Curve: Substitution effect dominates; labor supply increases with wage rates.
Backward-Bending Curve: Income effect dominates; labor supply decreases past a certain wage.