Scribd
Upload
25 views

Theory of Consumer Behavior

The document discusses the theory of consumer behavior including the consumer's budget, budget constraint, budget set, budget line, and how changes in income or prices affect these. It explains that given prices and income, the consumer will choose the consumption bundle on their budget line that maximizes their satisfaction as measured by indifference curves.

Uploaded by

Jasmine Jegan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
25 views

Theory of Consumer Behavior

The document discusses the theory of consumer behavior including the consumer's budget, budget constraint, budget set, budget line, and how changes in income or prices affect these. It explains that given prices and income, the consumer will choose the consumption bundle on their budget line that maximizes their satisfaction as measured by indifference curves.

Uploaded by

Jasmine Jegan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 30

Theory of Consumer Behavior (2)

Content
● Consumer budget
● Budget constraint
● Budget set
● Budget line
● Changes in budget line
● Changes in the income of the consumer
● Changes in the price of the good
● Optimal choice of the consumer
● Consumer equilibrium
Affordability
INCOME of the
consumer and
Consumer’s Budget PRICES of the goods

Based on available
consumption bundle
Assumptions
If the consumer wants to buy x₁,
have to spend p₁ x₁ amount of
money
Fixed Income of the consumer - M
Similarly, if the consumer wants to
There are only two goods - x₁ & x₂ buy x₂, have to spend p₂x₂ amount
Quantity of good 1 - x₁ of money
Quantity of good 2 - x₂

Prices of two goods - p₁ & p₂ consumption bundle


Price of good 1 - p₁ p₁x₁ + p₂x₂
Price of good 2 - p₂
consumption bundle Only if we have (p₁x₁ + p₂x₂)
p₁x₁ + p₂x₂ amount of money

Budget
constraint
Given the prices of the goods and
income of the consumer, a
consumer can choose any bundle as p₁x₁ + p₂x₂ ≤ M
long as it costs less than or equal to (inequality constraint)
the income
Budget set
Apple Guava Rupees
(Rs. 10) (Rs. 5) spent
p₁ p₂ (M=100)

A 5 (rs 50) 10 (rs 50) 100


It is the collection of all bundles
that the consumer can buy with her
B 6 (rs 60) 6 (rs 30) 90 income at prevailing price
C 6 (rs 60) 5 (rs 25) 85
(Set of bundles available to the
consumer)
D 4 (rs 40) 4 (rs 20) 60
The consumer’s budget set would
E 10(rs 100) 0 (rs 0) 100
consist of all bundles less than or equal
to income p₁x₁ + p₂x₂ ≤ M
Budget line
Equation: p₁x₁ + p₂x₂ = x₂ = M/p₂ - p₁/p₂ x₁
M

Horizontal intercept - M/p₁


All bundles on or below the line (spends entire income on x₁)
are included in the budget set. Vertical intercept - M/p₂
The line consist of all bundles cost (spends entire income onx₂)
exactly equal to income (M)

Slope of the budget line: - p₁/p₂


It is the rate at which the consumer substitute x₁ for x₂
p₁x₁ + p₂x₂ = M
Apple Banana Rupees
(Rs. 4) (Rs. 2) spent
p₁ p₂ (M=20)

E 5 (*4=20) 0 (*2=0) 20

F 4 (*4=16) 2 (*2=4) 20

G 3 (*4=12) 4 (*2=8) 20

H 2 (*4=8) 6 (*2=12) 20

I 1 (*4=4) 8 (*2=16) 20
E - M/p₁ = 20/4 = 5
J 0 (*4=0) 10 (*2=20) 20
J - M/p₂ = 20/2 =10
p₁x₁ + p₂x₂ = M 4x₁ + 2x₂ = 20
When x₂ = 0, x₁ = 5
Slope: - p₁/p₂ = - 4/2 = -2
When x₁ = 0, x₂ = 10
Budget line / Price line
Slope of a budget / price line
Consumption
bundles depends on
prices of the two
Changes in the goods and income of
the consumer
budget set

When the prices of either of the


goods changes or consumer’s
income changes
Budget line Equation: p₁x₁ + p₂x₂ =
Changes in income
M of the consumer
x₂ = M/p₂ - p₁/p₂
x₁
Income changes from M to M¹
Increase / decrease
Equation becomes p₁x₁ + p₂x₂ = (Prices of two goods remain
unchanged)
M¹
x₂ = M¹/p₂ - p₁/p₂ Note
x₁ Slope remains same

Changes in both
horizontal and vertical
intercepts
Increase in income M < M¹ Parallel outward shift
(intercepts increase)

Parallel inward shift


Decrease in income M > M¹ (intercepts decrease)
Change in the budget line when income
changes
Shift of a budget/ price line (change in income)
Change in price of
Budget line Equation: p₁x₁ + p₂x₂ =
M good x₁
x₂ = M/p₂ - p₁/p₂
x₁ changes from P to P¹
Price
Increase / decrease
Equation becomes p₁¹x₁ + p₂x₂ (Price of good x₂ and income
remain unchanged)
=M
x₂ = M/p₂ - p₁¹/p₂ Note
x₁ NO changes in vertical
intercepts (M/p₂)

Changes in slope
and horizontal
intercept
Value of the slope increases
Increase in price of (pivot inward & horizontal
p₁ <
intercept decreases - steeper)
good x₁ p₁¹

Decrease in price of Value of the slope decreases


p₁ > p₁¹ (pivot outward & horizontal
good x₁
intercept increases - flatter)
Change in the budget line when price of x₁
changes
Change in slope of a budget / priceline (change in
Based on consumer
taste and
preferences over the
Optimal choice of bundles in the
budget set
the consumer

Optimum point on the budget


line Consumer can choose
(Rational individual - what is any consumption bundle
good and what is bad) which is available in the
budget set.
BUT ON WHAT BASIS ?
It describes the bundles
Budget set that are available to the Highest
consumer possible IC
with available
budget set
Indifference It describes the
preferences over the
map
available bundle

A rational consumer always MAXIMUM


chooses the one which gives satisfaction
BL - price line/ budget line

Point below the line cannot be optimum


(Monotonic
preferences)
Point on the line would be optimum
Higher IC represents higher level of satisfaction

E - Equilibrium point

Consumer Equilibrium
(A point at which the budget line
is tangent to IC )
IC touching the budget line
is the highest possible IC
given the consumer’s
budget set (Point A)

Point B & D - not affordable

Point C - inferior

Any point on the budget


line lies on a lower IC is
inferior
It is the rate at which
Slope is determined by consumer is able to
Budget line price ratio = - p₁/p₂ substitute one good
for another

It is the rate at which


Indifference Slope is determined by consumer is willing
curve MRS = △Y / △X to substitute one
good for another

The optimum bundle of the consumer


is located at the point where the budget MRS = Price ratio
line is tangent to one of the IC
10X + 5Y = 100

M/Px = 100/10 = 10

M/Py = 100/5 =20

△Y / △X = 10/5 = 2

Px / Py = 10/5 = 2

MRS equals Price ratio


Consumer’s equilibrium

You might also like