PART II FOUNDATIONS OF MICROECONOMICS: CONSUMERS AND FIRMS

Chapter

6
Household Behavior and
Consumer Choice

Prepared by:
Fernando & Yvonn Quijano

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
 HOUSEHOLD CHOICE IN OUTPUT MARKETS
CHAPTER 6: Household Behavior and

Every household must make three basic decisions:

1. How much of each product, or output,

to demand
Consumer Choice

2. How much labor to supply

3. How much to spend today and how

much to save for the future

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 40
 HOUSEHOLD CHOICE IN OUTPUT MARKETS

THE BUDGET CONSTRAINT

CHAPTER 6: Household Behavior and

Information on household income and wealth,

together with information on product prices,
makes it possible to distinguish those
Consumer Choice

combinations of goods and services that are

affordable from those that are not.

budget constraint The limits imposed

on household choices by income,
wealth,
and product prices.

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 40
 HOUSEHOLD CHOICE IN OUTPUT MARKETS
CHAPTER 6: Household Behavior and

TABLE 6.1 Possible Budget Choices of a Person Earning $1,000 Per Month After Taxes
MONTHLY OTHER
OPTION RENT FOOD EXPENSES TOTAL AVAILABLE?
A $ 400 $250 $350 $1,000 Yes
B 600 200 200 1,000 Yes
Consumer Choice

C 700 150 150 1,000 Yes

D 1,000 100 100 1,200 No

choice set or opportunity set The set

of options that is defined and limited by
a budget constraint.

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 40
 HOUSEHOLD CHOICE IN OUTPUT MARKETS
The Budget Constraint More Formally
CHAPTER 6: Household Behavior and
Consumer Choice

FIGURE 6.3 Budget Constraint and Opportunity Set for Ann and
Tom
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 40
 HOUSEHOLD CHOICE IN OUTPUT MARKETS

THE EQUATION OF THE BUDGET CONSTRAINT

CHAPTER 6: Household Behavior and

In general, the budget constraint can be

written:
Consumer Choice

PXX + PYY = I,

where PX = the price of X, X = the

quantity of X consumed, PY = the price
of Y, Y = the quantity of Y consumed,
and I = household income.

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 40
 HOUSEHOLD CHOICE IN OUTPUT MARKETS

Budget Constraints Change When Prices Rise

CHAPTER 6: Household Behavior and

or Fall

FIGURE 6.4 The Effect of a

Decrease in Price on Ann
and Tom’s Budget
Consumer Choice

Constraint

The budget constraint is defined by income, wealth, and prices. Within those limits,
households are free to choose, and the household’s ultimate choice depends on its own
likes and dislikes.
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 40
 THE BASIS OF CHOICE: UTILITY
CHAPTER 6: Household Behavior and

utility The satisfaction, or reward, a

product yields relative to its
alternatives. The basis of choice.
Consumer Choice

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 40
 THE BASIS OF CHOICE: UTILITY

DIMINISHING MARGINAL UTILITY

CHAPTER 6: Household Behavior and

marginal utility (MU

(MU)) The additional
satisfaction gained by the consumption
or use of one more unit of something.
Consumer Choice

total utility The total amount of

satisfaction obtained from consumption
of a good or service.

law of diminishing marginal utility

The more of any one good consumed in
a given period, the less satisfaction
(utility)
generated by consuming each
additional
© 2007 (marginal)
Prentice Hall Business unitofof
Publishing Principles the 8e
Economics same
by Case and Fair 9 of 40
 THE BASIS OF CHOICE: UTILITY

TABLE 6.2 Total Utility and Marginal

CHAPTER 6: Household Behavior and

Utility of Trips to the Club

Per Week
TRIPS TOTAL MARGINAL
TO CLUB UTILITY UTILITY
1 12 12
2 22 10
Consumer Choice

3 28 6
4 32 4
5 34 2
6 34 0

FIGURE 6.5 Graphs of Frank’s

Total and Marginal Utility

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 40
 THE BASIS OF CHOICE: UTILITY

THE UTILITY-MAXIMIZING RULE

CHAPTER 6: Household Behavior and

In general, utility-maximizing consumers spread out their

expenditures until the following condition holds:
Consumer Choice

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 40
 THE BASIS OF CHOICE: UTILITY

DIMINISHING MARGINAL UTILITY AND

CHAPTER 6: Household Behavior and

DOWNWARD-SLOPING DEMAND

FIGURE 6.6 Diminishing Marginal Utility

Consumer Choice

and Downward-Sloping
Demand

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 40
 Appendix

INDIFFERENCE CURVES
CHAPTER 6: Household Behavior and

ASSUMPTIONS
We base the following analysis on four assumptions:

1. We assume that this analysis is restricted to goods that

Consumer Choice

yield positive marginal utility, or, more simply, that “more

is better.”
2. The marginal rate of substitution is defined as MUX/
MUY, or the ratio at which a household is willing to
substitute X for Y. We assume a diminishing marginal
rate of substitution.
3. We assume that consumers have the ability to choose
among the combinations of goods and services
available.
4. We assume that consumer choices are consistent with a
simple assumption of rationality.
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 40
 Appendix

PROPERTIES OF INDIFFERENCE CURVES

CHAPTER 6: Household Behavior and
Consumer Choice

If we divide both sides by MUY and by Δ X, we obtain

The slope of an indifference curve is the ratio of the marginal utility of X to the marginal
utility of Y, and it is negative.
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 40
 Appendix

CONSUMER CHOICE
CHAPTER 6: Household Behavior and

FIGURE 6A.3 Consumer Utility-

Maximizing
Equilibrium
Consumer Choice

As long as indifference curves are convex to the origin, utility maximization will take place at
the point at which the indifference curve is just tangent to the budget constraint.
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 40
 Appendix
CHAPTER 6: Household Behavior and

Where two curves are tangent, they have the same slope,
which implies that the slope of the indifference curve is
exactly equal to the slope of the budget constraint at the
point of tangency:
Consumer Choice

slope of indifference curve = slope of budget constraint

By multiplying both sides of this equation by MUY and

dividing both sides by PX, we can rewrite this utility-
maximizing rule as

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 40
 Appendix

DERIVING A DEMAND CURVE FROM INDIFFERENCE

CHAPTER 6: Household Behavior and

CURVES AND BUDGET CONSTRAINTS

Consumer Choice

FIGURE 6A.4 Deriving a Demand Curve from Indifference Curves and Budget
Constraint
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 40