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Chapter 4Chapter 4Prof. DrProf. Dr . .

Mohamed I. MigdadMohamed I. MigdadProfessor in EconomicsProfessor in Economics

20152015

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Chapter 4Chapter 4

DemandDemand & & Consumer BehaviorConsumer Behavior

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AssumptionsAssumptions• A key assumption in the A key assumption in the

study of household and study of household and firm behavior is that all firm behavior is that all input and output markets input and output markets are are perfectly perfectly competitive.competitive.

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Household Choice in Output Household Choice in Output MarketsMarkets

Every household must make Every household must make three three basic decisions:basic decisions:1.1.How much of each product, or output, to How much of each product, or output, to

demand.demand.2.2.How much labor to supply.How much labor to supply.3.3.How much to spend today and how How much to spend today and how

much to save for the future.much to save for the future.

Assumptions to understand Assumptions to understand the consumer behaviorthe consumer behavior

1.1. The consumer should behave rationally. The consumer should behave rationally. 2.2. Consumers' taste and preference should be fixed Consumers' taste and preference should be fixed

while studying their behavior.while studying their behavior.3.3. Consumers' income should be limited and mostly Consumers' income should be limited and mostly

spent on goods and services to reach the highest spent on goods and services to reach the highest level of satisfaction, which means that level of satisfaction, which means that consumer, most likely, will not save any of consumer, most likely, will not save any of his/her income. his/her income.

4.4. A consumer is only A consumer is only oneone buyer which means that buyer which means that s/he doesn’t affect the price or quantity s/he doesn’t affect the price or quantity demanded or supplied. demanded or supplied.

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The Determinants of The Determinants of Household DemandHousehold Demand

1.1. The The price of the productprice of the product in in question.question.

2.2. The The incomeincome available to the available to the household.household.

3.3. The householdThe household’’s amount of s amount of accumulated wealthaccumulated wealth..

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continuecontinue4.4. The The prices of related productsprices of related products

available to the household.available to the household.5.5. The householdThe household’’s s tastes and tastes and

preferencespreferences..6.6. The householdThe household’’s s expectationsexpectations

about future income, wealth, and about future income, wealth, and prices.prices.

how could a consumer how could a consumer distribute the limited distribute the limited income in order to satisfy income in order to satisfy wants? wants?

There are two ways:There are two ways:

First: The Traditional Way (The First: The Traditional Way (The Marginal Utility Theory)Marginal Utility Theory)

Second: The Modern Way (The Second: The Modern Way (The Indifference Curve Theory)Indifference Curve Theory)

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Marginal Utility TheoryMarginal Utility Theory In this section we will shed some light on:In this section we will shed some light on:The difference between Marginal and The difference between Marginal and

Total utility.Total utility.The balance of consumers using The balance of consumers using

marginal utility theory.marginal utility theory.Deriving the consumer demand curve.Deriving the consumer demand curve.Problem facing the marginal utility Problem facing the marginal utility

theory.theory.

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The Difference between The Difference between Marginal and Total Marginal and Total

UtilityUtility Total Utility (TU) Total Utility (TU) is the aggregate level of is the aggregate level of

satisfaction or fulfillment that a consumer satisfaction or fulfillment that a consumer receives through the consumptions of a receives through the consumptions of a specific good or service in a given period of specific good or service in a given period of time. time.

Marginal Utility (MU)Marginal Utility (MU), however, is the amount , however, is the amount of change in TU which is affected by the of change in TU which is affected by the increase in consumption of one additional unit. increase in consumption of one additional unit. It is also the utility of the last consumed unit.It is also the utility of the last consumed unit.

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mathematically from for the mathematically from for the MUMU

Marginal Utility (MU)=Marginal Utility (MU)= Change in total utility of a product /Change in total utility of a product /Change in consumed quantity of the Change in consumed quantity of the

productproduct

MU = TU / QMU = TU / Q

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The Basis of Choice: UtilityThe Basis of Choice: UtilityUtilityUtility is the satisfaction, or reward, is the satisfaction, or reward,

a a product yields relative to its product yields relative to its alternatives. The basis of choice.alternatives. The basis of choice.

Marginal utilityMarginal utility is the is the additional satisfaction gained by additional satisfaction gained by the consumption or use of one the consumption or use of one more unit of something.more unit of something.

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Diminishing Marginal UtilityDiminishing Marginal UtilityThe The law of diminishing law of diminishing

marginal utility:marginal utility:The more of one good consumed in The more of one good consumed in

a given period, the less satisfaction a given period, the less satisfaction (utility) generated by consuming (utility) generated by consuming each additional (marginal) unit of each additional (marginal) unit of the same good.the same good.

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Diminishing Marginal UtilityDiminishing Marginal UtilityTotal Utility and Marginal Utility of chocolate Per WeekTotal Utility and Marginal Utility of chocolate Per Week

Chocolate BarsChocolate BarsMARGINAL UTILITYMARGINAL UTILITYTOTAL UTILITYTOTAL UTILITY

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ContCont.. Total utilityTotal utility increases at a increases at a decreasing decreasing rate, until it is rate, until it is constant. constant. Then it Then it decrease decrease

while while marginal marginal utilityutility decreases decreases until equal until equal zero and then zero and then it became it became negative negative

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Diminishing Marginal UtilityDiminishing Marginal Utilityand Downward-Sloping and Downward-Sloping

DemandDemandDiminishing marginal utility Diminishing marginal utility

helps to explain why demand helps to explain why demand slopes down.slopes down.

Marginal utility falls with each Marginal utility falls with each additional unit consumed, so additional unit consumed, so people are not willing to pay people are not willing to pay as much. See the next graphas much. See the next graph

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Consumer EquilibriumConsumer EquilibriumWe reach Consumer equilibrium condition We reach Consumer equilibrium condition

as following:as following:First condition:First condition:marginal utility of good X / price of good Xmarginal utility of good X / price of good X= marginal utility of good Y/ price of good Y= marginal utility of good Y/ price of good Y= Marginal utility for money= Marginal utility for moneyMarginal utility for money = MU Y /P YMarginal utility for money = MU Y /P Y = MU X / P X= MU X / P X

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Second condition: Second condition: Consumers should spend all their Consumers should spend all their

income on two products and the income on two products and the formula is as follows: formula is as follows:

Income=Income= (quantity of X * price of product X) + (quantity of X * price of product X) +

(quantity of Y * price of product Y) (quantity of Y * price of product Y)

I = Qx * Px + Qy * PyI = Qx * Px + Qy * Py1919

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The Budget ConstraintThe Budget ConstraintThe The budget constraintbudget constraint refers refers

to the limits imposed on to the limits imposed on household choices by income, household choices by income, wealth, and product prices.wealth, and product prices.

A A choice setchoice set or or opportunity opportunity setset is the set of options that is is the set of options that is defined by a budget constraint.defined by a budget constraint.

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continuecontinueA A budget constraintbudget constraint separates separates

those combinations of goods and those combinations of goods and services that are available, given services that are available, given limited income, from those that limited income, from those that are not.are not.

The available combinations make The available combinations make up the up the opportunity setopportunity set..

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continuecontinue

The following is the budget constraint The following is the budget constraint when income equals $200 dollars per when income equals $200 dollars per month, the price of jazz club visits is month, the price of jazz club visits is $10 each, and the price of a Thai meal $10 each, and the price of a Thai meal is $20.is $20.

One of the possible combinations is 5 One of the possible combinations is 5 Thai meals and 10 Jazz club visits per Thai meals and 10 Jazz club visits per month.month.

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continuecontinuePoint Point EE in the next graph in the next graph

is unattainable given the is unattainable given the current income prices.current income prices.

Point Point DD does not exhaust does not exhaust the entire income the entire income available.available.

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contcont..

A decrease in the price of A decrease in the price of Thai meals shifts the budget Thai meals shifts the budget line outward along the line outward along the horizontal axis.horizontal axis.

• The decrease in the price of The decrease in the price of one good expands the one good expands the consumerconsumer’’s opportunity set.s opportunity set.

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Indifference CurvesIndifference CurvesAn An indifference curveindifference curve is a set of is a set of

points , each point representing a points , each point representing a combination of goods combination of goods XX and and YY, all of , all of which (combination) yields the same which (combination) yields the same total utility. total utility.

The consumer is worse of at The consumer is worse of at AA’’ than at than at AA. because . because AA’’ includes lower amount of includes lower amount of Y and the same amount of X compare Y and the same amount of X compare with A.with A.

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continuecontinueAny point on the indifference curveAny point on the indifference curve

yields the same total utility.yields the same total utility.Any point to the left of the Any point to the left of the indifference indifference

curvecurve yields lower total utility.yields lower total utility.Any point to the right of the Any point to the right of the

indifference curveindifference curve yields higher total yields higher total utility.utility.

the indifference curvethe indifference curve includes includes infinity points (Combination). infinity points (Combination).

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Indifference CurvesIndifference CurvesA A preference mappreference map is a whole set of is a whole set of

indifference curves.indifference curves.A A preference map includes infinity preference map includes infinity

number of indifference curvesnumber of indifference curveswhen indifference curves shift to when indifference curves shift to

the left, it indicate lower utility the left, it indicate lower utility And when it shift to the right it And when it shift to the right it

indicate higher utility. indicate higher utility.

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continuecontinueEach consumer has a unique Each consumer has a unique

preference map. preference map. As we move downward along an As we move downward along an

indifference curve, the indifference curve, the marginal marginal rate of substitutionrate of substitution (MRS) (MRS) declines.declines.

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Indifference CurvesIndifference Curves

Consumers will choose the Consumers will choose the combination of X and Y that combination of X and Y that maximizes total utility. maximizes total utility.

Graphically, the consumer will move Graphically, the consumer will move along the budget constraint until the along the budget constraint until the highest possible indifference curve is highest possible indifference curve is reached.reached.

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The consumer equilibriumThe consumer equilibrium

The equilibrium will happen when the The equilibrium will happen when the budget line touch the highest budget line touch the highest indifference curve in the indifferent indifference curve in the indifferent map. map.

The two slopes are equals The two slopes are equals

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demand curve & utilitydemand curve & utilityTo obtain the demand curve To obtain the demand curve

for good X, we change the for good X, we change the price of good X and observe price of good X and observe the change in the quantity of the change in the quantity of X demanded.X demanded.

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The effect of increasing income

• When income increase the budget line will move to the right.

• When income decrease the budget line will move to the left.

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The effect of changing prices

• The budget line will turn from one side only depending on the change in price.

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Consumer Surplus

• Consumer surplus is the difference between the maximum amount a person is willing to pay for a good and its current market price.

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Consumer Surplus

• Some consumers are willing to pay as much as $5 each for hamburgers.

• Since the price is only $2.50, they receive a consumer surplus of $2.50.

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Consumer Surplus

• Others are willing to pay something less than $5.00 but more than $2.50.

• Consumer surplus is the area below the demand curve and above the price level

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