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Chapter 3 12005 Pearson Education, Inc.

Short-Run Versus Long-Run

Elasticity (pp. 38 - 46)

Price elasticity varies with the amount oftime consumers have to respond to a

price

Short-run demand and supply curvesoften look very different from their long-

run counterparts

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Short-Run vs. Long-Run

Elasticity An Application (pp. 45 - 6)

Why are coffee prices very volatile?Most of the worlds coffee is produced in

Brazil

Many changing weather conditions affect the

crop of coffee, thereby affecting price

Price following bad weather conditions is

usually short-lived

In long run, prices come back to original

levels, all else equal

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Price of Brazilian Coffee (pp. 45 - 6)

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Short-Run vs. Long-Run

Elasticity An Application (pp. 45 - 6)

Demand and supply are more elastic in

the long run

In the short run, supply is completely

inelasticWeather may destroy part of the fixed supply,

decreasing supply

Demand is relatively inelastic as wellPrice increases significantly

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D

P0

S

Q0 Quantity

Price

A freeze or droughtdecreases the supply

of coffee

S

Q1

An Application - Coffee (pp. 45 - 6)

Price increases

significantly due to

inelastic supply and

demand

P1

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S

D

S

P0

Q0

P2

Q2

Intermediate-Run

1) Supply and demand aremore elastic

2) Price falls back to P2.


Quantity

Price

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SP0

Q0

Long-Run

1) Supply is extremely elastic2) Price falls back to P

0.

3) Quantity back to Q0.


Quantity

Price

D

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Chapter 3

Consumer Behavior

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Introduction (pp. 64 - 5)

How are consumer preferences used to

determine demand?

It is very likely that your consumption pattern isdifferent from any of your friends with more or less

same income.

How do consumers allocate income to

the purchase of different goods?

Do you spend your income only on phone bills?

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Introduction (pp. 64 - 5)

How do consumers with limited income

decide what to buy?

Do you think a family with no babies spend theirincome for babys items?

How can cost of living indexes measure

the well-being of consumers?

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Consumer Behavior(pp. 64 - 5)

The theory of consumer behavior can be

used to help answer these and many

more questions

Theory of consumer behaviorThe explanation of how consumers allocate

income to the purchase of different goods

and services, or theories behinds consumer

demand curves, QD=QD(P, )

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Example: Consumption patterns of

Japanese Households (See the figures

on my handouts. The figures are taken

from Kakei Chosa (Family Income and

Expenditure Survey, Ministry of Internal

Affairs and Communications))

http://www.stat.go.jp/english/data/kakei/index.htm

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There are three steps involved in the

study of consumer behavior

1. Consumer Preferences

To describe how and why people preferone good to another (You have

preferences)

2. Budget Constraints People have limited incomes (Opportunities

are limited)

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3. Given preferences and limited incomes,

what amount and type of goods will be

purchased?

What combination of goods will consumers

buy to maximize their satisfaction? (Make a

rationaloroptimalchoice)

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Consumer Preferences (pp. 65 - 79)

How might a consumer compare differentgroups of items available for purchase?

A market basketis a collection of one ormore commodities

Individuals can choose between marketbaskets containing different goods

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Consumer Preferences Basic

Assumptions (pp. 65 - 79)

1. Preferences are complete Consumers can rank market baskets

2. Preferences are transitive If they prefer A to B, and B to C, they must

prefer A to C

3. Consumers always prefer more of anygood to less

The more, the better

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Consumer Preferences (pp. 65 - 79)

Consumer preferences can be

represented graphically using

indifference curves (for the case of 2

goods)

Indifference curves represent all

combinations of market baskets that the

person is indifferent toA person will be equally satisfied with either

choice

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Indifference Curves:

An Example (pp. 65 - 79)

4010H

2010G

4030E

2040D

5010B

3020A

Units of ClothingUnits of FoodMarket Basket

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Graph the points with one good on the x-

axis and one good on the y-axis

Plotting the points, we can make some

immediate observations aboutpreferences

The more, the better

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The consumer prefersA to all combinations

in the yellow box, while

all those in the pink

box are preferred to A.



Food

10

20

30

40

10 20 30 40

Clothing 50

G

A

EH

B

D

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Points such as B & D have more of one

good but less of another compared to ANeed more information about consumer

ranking

Consumermaydecide they areindifferent between B, A and DWe can then connect those points with an

indifference curve

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Indifferent

between points B,

A, & D

E is preferred to

any points on the

indifference curve

U1Points on U

1arepreferred to H & G



Food

10

20

30

40

10 20 30 40

Clothing50

U1G

D

A

EH

B

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Indifference Curves (pp. 65 - 79)

Any market basket lying northeast of an

indifference curve is preferred to any

market basket that lies on the

indifference curve

Points on the curve are preferred to

points southwest of the curve

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Indifference curves slope downward to

the right

If they sloped upward, they would violate the

assumption that more is preferred to less

Some points that had more of both goods would

be indifferent to a basket with less of both goods

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To describe preferences for all

combinations of goods/services, we have

a set of indifference curves an

indifference map

Each indifference curve in the map shows

the market baskets among which the person

is indifferent

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U2

U3

Indifference Map (pp. 65 - 79)

Food

Clothing

U1

AB

D

Market basketAis preferred to B.

Market basket B is

preferred to D.

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Indifference Maps (pp. 65 - 79)

Indifference maps give more information

about shapes of indifference curves

Indifference curves cannot cross

Violates assumption that more is better

Why? What if we assume they can cross?

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Indifference Maps (pp. 65 - 79)

Food

Clothing

B is preferred to D

A is indifferent to B & D

B must be indifferent toD but that cant be if B is

preferred to D. A

contradiction

U1

U1

U2

U2

A

B

D

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The shapes of indifference curves

describe how a consumer is willing to

substitute one good for another

A to B, give up 6 clothing to get 1 food

D to E, give up 2 clothing to get 1 food

The more clothing and less food a person

has, the more clothing they will give up toget more food

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A

B

D

E

G-1

-6

1

1

-4

-21

1

Observation: The amount

of clothing given up for

1 unit of food decreases

from 6 to 1


Food

Clothing

2 3 4 51

2

4

6

810

12

14

16

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We measure how a person trades one

good for another using the marginal rate

of substitution (MRS)

It quantifies the amount of one good a

consumer will give up to obtain more of

another good, or the individual terms of trade

It is measured by the slope of the

indifference curve

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