SV_ECONS101_Topic02

Topic 2: A Model of Choices

Brand Camp

• Inside the mind of the consumer involves various influences:

  • Kids

  • Husband

  • Friends

  • Parents

  • Career choices

  • Charities

  • Travel experiences

  • Personal interests (e.g., sunsets, home, historical novels)

• Comic illustration by Tom Fishburne showcases consumer behavior and awareness of branding.

Reminders

• Sign up for tutorials starting this week.

• Print and attempt the tutorial sheet from Moodle.

• Extra credit available for completing an additional survey with Cornell University (worth 2 bonus marks for Test 1).

• Daily Question of the Day available on Moodle, quizzes are not retrievable if missed.

Economic Literacy Pre-Test Results

• Mean: 26.1 out of 45 (compared to U.S. mean of 23.2; 27.0 for individuals who took high school economics).

• Median: 26.0 out of 45.

Lifetime Hours

• Analyzes the increase in leisure hours over time compared to work hours.

• Visual representation shows the increase from 1880 to projected figures in 2040.

Explaining Consumer Behavior: Consumer Choice Model

• Economics primarily revolves around choices.

• Choices are limited by available alternatives and personal income.

• The consumer choice model was developed by Roy Allen in 1934 and further explored by John Hicks (1972 Nobel Prize winner).

• Graphical representation is used to illustrate choices between two goods (X and Y axes).

The Budget Constraint

Definition and Concept

• Refers to the limitations imposed by consumer income on purchasing decisions.

• Equation: Income = Expenditure (illustrative of how consumers spend accordingly).

Key Features

• Rearranging the budget equation leads to a linear representation:[ C = M - (P_x/Q_x)Y ]

  • with y-intercept M/P_y and slope -P_x/P_y (relative price).

• The budget constraint is similar to an iso-cost line where all bundles of goods have the same total cost.

• The line illustrates feasible consumption bundles that consumers can afford.

Changes in the Budget Constraint

• The budget constraint shifts with changes in price of goods or consumer income.

• Visual examples clarify how budget constraints vary with price increase/decrease and income fluctuations.

Budget Constraint Examples

Example 1

• Analyze effects of price changes on the budget line for two goods.

Example 2

• Consumer with M=$100 for beer ($5) and donuts ($2); plotting various purchasing combinations on a graph.

Example 3

• Determine shifts in Homer’s budget constraint based on changes in donut prices or income.

Relative Prices and Opportunity Cost

• Slope signifies opportunity cost (-Px/Py), indicating trade-offs between goods.

• A steep slope indicates a high opportunity cost for a good, while a flat slope suggests a low opportunity cost.

Comparing Bundles of Goods

• The budget constraint separates affordable from unaffordable bundles.

• Consumer preferences among feasible bundles can indicate potential purchasing outcomes.

Utility

Definition

• Utility measures satisfaction or happiness derived from consumption.

• Consumers aim to maximize their utility through their purchases.

Diminishing Marginal Utility

• Consumption is subject to diminishing returns in satisfaction levels; additional units yield less satisfaction as consumption increases.

• Graphically represented where utility decreases at higher consumption levels.

Indifference Curves

Concept

• Illustrates combinations of goods yielding equal satisfaction.

• Key attributes:

  • Higher indifference curves indicate higher utility.

  • Curves cannot cross.

Marginal Rate of Substitution (MRS)

• MRS indicates how much of Good Y a consumer is willing to give up for an additional unit of Good X, depicted by indifference curves' slope.

• Changes in slope reflect varying marginal utilities as consumption amounts shift.

Special Cases of Indifference Curves

• Perfect substitutes (identical goods) and perfect complements (goods consumed together at fixed ratios) are notable exceptions.

Best Affordable Choice

• Represents the consumption bundle maximizing utility under budget constraints.

• Optimal choice occurs where MRS equals the slope of the budget constraint.

Example: The Law of Demand

• Analytical demonstration showing that a decrease in the price of a good results in increased purchasing quantity, substantiating the Law of Demand.

Income Changes and Consumer Choice

Normal vs. Inferior Goods

• Normal goods: Demand increases with rising income.

• Inferior goods: Demand decreases as income increases.

Application of Choice Model in Labour and Saving

Labour Decisions

• Examines allocation of time between work (income generation) and leisure, showing preferences with an indifference curve model.

Savings Behaviour

• Consumers allocate income between current and future consumption; the budget constraint slope equals the interest rate.

Conclusion

Economists' Application

• The constrained optimization model underlies economic decision-making, explaining consumer choices amid changing economic conditions.

Learning Objectives

• Describe features of consumer choice and constrained optimization models.

• Explain consumer behavior relative to price and income changes.

• Understand income and substitution effects along with consumer decisions regarding leisure and savings.