theory of consumer choice
TRANSCRIPT
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A presentation on Theoryof consumer choice.
Sidharth Yadav
Roll no. 531
Section I
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IntroductionThe theory of consumer choice eamines the
trade!o"s that people face in their role asconsumers. It eamines ho# consumers facin$these trade!o"s ma%e decisions and ho# theyrespond to chan$es in their environment.
Three &asic 'uestions concernin$ householddecisions are (
)o all demand curves slope do#n#ard*
+o# do #a$es a"ect la&or supply*
+o# do interest rates a"ect household savin$*
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,ud$et -onstraint /hat the
consumer can a"ord*0eople consume less than they desire &ecause
their spendin$ is constrained or limited &y theirincome. /e &e$in the study of consumer choice
&y eaminin$ the lin% &et#een income andspendin$.
,ud$et constraint is the limit on the consumption&undles that a consumer can a"ord. /hen
represented $raphically it is called a &ud$et line.
1. ,ud$et line of aconsumer consumin$ 2
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0references /hat the consumer #ants*
The &ud$et constraint in the previous slidesho#s the trade o" that the consumer faces&et#een $ood 4Y.
,ut the consumers choices depend not only onthe constraints and also his preferences.
A consumers preferences lets him choose
amon$st di"erent &undles of the same $ood.A curve #hich sho#s the &undles #hichprovide e'ual satisfaction to the consumer iscalled an indi"erence curve. )i"erent
indi"erence curves depict di"erent levels of
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Indi"erence -urve
2. I- sho#in$ &undles A,6 of$oods 4Y.
0roperties of an I-
+i$her I-s represent hi$her satisfaction.I-s are al#ays do#n#ard slopin$.2 I-s never intersect.I-s are al#ays conve.
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7ptimi8ation /hat the consumerchooses*
9. :i$ure sho#in$ di"erent I-s alon$ #ith the &ud$et line of aconsumer consumin$ 2 $oods 4Y. ,- is the &ud$et line.
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/ith reference to the previous slide
The consumer chooses the point on his &ud$etconstraint that lies on the hi$hest I-. At this pointslope of the I- ; slope of the &ud$et line.
+ere the hi$hest I- that the consumer can reach isI-3. The consumer prefers I-9 and I-5 &ut theconsumer cannot a"ord any &undle on these I-s asthey are a&ove the &ud$et line.
,y contrast I-1 and I-2 are a"orda&le &ut theconsumer #ould not prefer them as they o"er a lo#erlevel of satisfaction as compared to I-3.Therefore the optimum point of consumption for thisconsumer is the point of tan$ency A6 of I-3 and
&ud$et line ,-.
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-han$e in 0rices.The impact of chan$e in the price of a $ood
on its consumption can &e decomposed intot#o e"ects!
1. Income e"ect
2. Su&stitution
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Income
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Su&stitution
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0rice
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The Three Applications)o all demand curves slope
do#n#ard*
+o# do #a$es a"ect la&or supply*
+o# do interest rates a"ecthousehold savin$*
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)o all demand curves slope do#n#ard*
As a matter of economic theory demand curvescan sometimes slope up#ards also. In thiscase the consumers violate the la# ofdemand.
This happens in case of a $i"en $ood.
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+o# do #a$es a"ect la&or supply*0eople spend some of their time enBoyin$
leisure and some of it #or%in$ so they cana"ord to &uy $oods. The essence of the time!
allocation pro&lem is the trade!o" &et#eenleisure and consumption.
The #or%!leisure decision sho#s a persons
&ud$et constraint for decidin$ ho# much to#or% his I-s for consumption and leisure andhis optimum.
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An increase in the #a$es (0anel A
C. In panel A a hi$her #a$e induces the person to enBoy lessleisure and #or% more so the la&or supply curve slopes up#ard.
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An increase in the #a$es (0anel ,
D. In panel , a hi$her #a$e induces the person to enBoy moreleisure and #or% less so the la&or supply curve slopes &ac%#ard.
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0anel A vs. ,In panel A #hen #a$es rise leisure &ecomes more
costly relative to consumption and this encoura$es himto su&stitute a#ay from leisure and to#ards
consumption. Ea&or supply curve slopes up#ard.In panel , #hen #a$es rise he moves to a hi$her I-.
As lon$ as consumption and leisure are &oth normal$oods he tends to #ant to use this increase in #ell!&ein$ to enBoy &oth hi$her consumption and $reater
leisure. Ea&or supply curve slopes &ac%#ard.If the su&stitution e"ect is $reater than income e"ect
he #or%s more. If income e"ect is $reater thansu&stitution he #or%s less. The la&or supply curvetherefore could &e either up#ard or &ac%#ard slopin$.
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+o# do interest rates a"ect
household savin$*An important decision that every person facesis ho# much income to consume today andho# much to save for the future.
1F. This G$ure sho#s the&ud$et constraint for aperson decidin$ ho#
much to consume in thet#o periods of his lifethe I-s representin$ hispreferences and theoptimum.
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/hen the interest rate increases
11. In &oth panels an increase in the interest rate shifts the&ud$et constraint out#ard. In the panel on the left consumption#hen youn$ falls. The result is an increase in savin$ #hen youn$.In the panel on the ri$ht consumption in &oth period rises resultis decrease in savin$ #hen youn$.
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Than% YouH