Lecture 8 2024-25 - ECON10720-Microeconomics for Business-2024_25 Spring

Consumer Behavior and Effects of Price Changes

Basic Concepts

• Vertical Intercept: Y/Pc (where Y is income, Pc is price of C)

• Horizontal Intercept: Y/PB (where Pb is price of B)

• Slope: -PB/Pc (indicates rate of substitution between B and C)

Price Changes and Consumption Effects

Effect of Price Change on Goods

• Fall in Price of B: Results in a rise in equilibrium consumption of B; effects on consumption of C unclear without more context.

• Equilibrium Consumption: Refers to the point where demand and supply balance for goods B and C.

Substitution and Income Effects

Understanding Total, Income, and Substitution Effects

• Total Effect: Movement from point 1 to 3.

• Income Effect: Change in consumption as a result of income change from point 1 to 2.

• Substitution Effect: Change in consumption from point 2 to 3 due to relative price changes between B and C.

Directions of Effects on Consumption (Assuming PB Falls)

Classifications

• Own Price Effects (B)

  • Normal Goods: Consumption increases with a decrease in price.

  • Inferior Goods: Consumption decreases with a decrease in price.

• Cross Price Effects (C)

  • Normal Goods: Consumption increases when the price of B falls.

  • Inferior Goods: Consumption decreases when the price of B falls.

Summary of Effects

• Income Effect:

  • Normal: Increase (↑)

  • Inferior: Decrease (↓)

• Substitution Effect:

  • Normal: Increase (↑)

  • Inferior: Decrease (↓)

• Total (Price) Effect:

  • Typically positive for normal goods and negative for inferior goods.

Demand Curve Implications

• Giffen Goods: Exceptions where negative income effect outweighs positive substitution effect, resulting in higher consumption despite a price increase.

• Demand Curve: Mapping relationship between the price of a good and quantity demanded across various price points.

Individual vs Market Demand Curves

Transitioning from Individual to Market Demand

• Moving from individual demand curves (q) to market demand curves (Q) occurs through horizontal addition.

• Changes in quantity demanded might happen at intensive (existing consumers) or extensive (new consumers) margins.

Factors Affecting Demand Curve

Movement versus Shift

• Change in Own-Price: Movement along the demand curve.

• Change in Other Factors: Leads to shifts in the demand curve, including:

  • Income: Normal vs Inferior goods.

  • Price of Other Goods: Complements vs Substitutes.

  • Tastes and Fashion: Impact demand dynamic.

Note**: Important to differentiate between movements along the curve and shifts in the demand curve.

Utility Maximization Critique

Assumptions of Rationality

• Models assume consumers have a high degree of rationality, which may not represent real-life decisions.

• Behavioral Economics: Introduces concepts of 'bounded rationality' highlighting systematic consumer "mistakes":

  • Overconfidence: Misjudging abilities or outcomes.

  • Heuristics: Simple rules for decision making that can lead to biases.

    • Anchoring: Relying too heavily on the first piece of information encountered.

    • Availability: Estimating likelihood based on immediate examples.

    • Framing Effects: Decisions influenced by how choices are presented, not just the choices themselves.

Framing Effects (Kahneman/Tversky)

Illustrative Examples

• Option A vs B (200 saved vs probability outcomes): Most choose A emphasizing gains.

• Option C vs D (400 dead vs probability outcomes): Most choose D, framing focuses on loss.

• Conclusion: A and C are equivalent, as are B and D, but decisions diverge based on gain/loss framing.