Consumer BehaviorConsumer Behavior 4. Introduction 4 Chapter Outline 4.1 The Consumer’s Preferences and the Concept of Utility 4.2 Indifference Curves 4.3 The Consumer’s Income

Consumer Behavior

4

Introduction 4

Chapter Outline

4.1 The Consumer’s Preferences and the Concept of Utility

4.2 Indifference Curves

4.3 The Consumer’s Income and the Budget Constraint

4.4 Combining Utility, Income, and Prices:

What Will the Consumer Consume?

4.5 Conclusion

4

How do consumers make purchases?

• This chapter introduces a theory of consumer behavior

• The theory is used to investigate why consumers make

purchases

• Ultimately, consumers are assumed to “optimize” their

utility given scarce resources

• Consumer theory is the basis for the “demand” side of the

supply and demand model

Introduction

The Consumer’s Preferences and

the Concept of Utility 4.1

Economists assume consumers are rational and able to “optimize”consumption decisions given scarce resources

Four assumptions about consumer preferences

Completeness and rankability1.

Consumers can compare bundles of goods and rank them•

For most goods, more is better than less2.

Non• -satiation and “free disposal”

Transitivity3.

Imposes consistency on rankings•

The more a consumer has of a particular good, the less she is 4.

willing to give up of something else to get even more of that good

Referred to as • “diminishing marginal utility”



The Concept of Utility

Utility is a measure of how “satisfied” consumers are

• A measure of happiness or satisfaction

• Provides a theoretical basis for decision theory

A utility function describes the relationship between what

consumers actually consume and their level of well-being

• Can take a variety of mathematical forms

• Common assumptions: continuous, differentiable, concave




Consider the utility someone enjoys from seeing a movie in a theater vs.

watching a DVD

where T is the number of movies “consumed” at the theater, and D is

the number of DVDs consumed at home. Utility might be represented by

In general, movies consumed in the theater add more utility than those

consumed at home

* this particular functional form is referred to as “Cobb–Douglas”

U =U T,D( )

U =T 0.8D0.2




Marginal utility is the additional utility a consumer receives from

an additional unit of a good or service.




Continuing the previous example, the marginal utility of theater-movies

for this consumer is given by

or, with the prescribed parameters

MUT =DU T,D( )

DT=dU T,D( )dT

MUT = 0.8T -0.2D0.2



Comparing Consumption Outcomes

The “rules” for utility allows only for an ordinal ranking of

consumption bundles

• An ordinal ranking implies bundles can be ranked from best to worse

• A cardinal ranking would allow a person to determine how much

better one bundle is, compared to another

Why not cardinal?

• Many questions can be answered with only an ordinal ranking

– Ex: Predicting what will be consumed

• Consumers differ in preferences

‒ Ex: Both between consumers and over time

Indifference Curves 4.2

Ordinal rankings mean we care about relative outcomes

• Some bundles are better than others, some are worse

• Start by considering bundles that are relatively equal

A consumer is indifferent between bundles when he or she

derives the same utility level from two or more bundles.

An indifference curve plots out all of the consumption

bundles that provide a consumer with the same level of

utility or satisfaction.


Figure 4.1 Building an Indifference Curve

Numberof friends

living inbuilding

A10

B5

C3

Indifferencecurve (U)

0 500 750 1,000 Apartment size (square feet)


Characteristics of Indifference Curves

1. They can be drawn

• Completeness and rankability

2. Curves further from the origin represent higher utility

• More is better

3. Curves never cross

• Transitivity

4. Convex to the origin

• Diminishing marginal utility


Figure 4.2 A Consumer’s Indifference Curves

Numberof friends

living inbuilding

5

U2

U1

0 500 1,000

U2 has a greater utility

than U1

Apartment size (square feet)


Indifference curves can never cross

Call our movie watcher, Joe

To see why indifference curves cannot cross,

consider bundles D and F• These bundles are on the same indifference

curve, therefore Joe must be indifferent between

them

Now, draw another indifference curve through

bundle F that intersects the original curve • Implies Joe is also indifferent between points E

and F as well as between points E and D

Why must Joe prefer bundle E to bundle D?

‒ If more is better, at E he has more of

both

EF

D

Movies at the

Theater

DVDs


Figure 4.4 Tradeoffs Along an Indifference Curve

Numberof friends

Aliving inbuilding

B

U1

As apartment size gets larger, Michaelais less willing to trade off the number

of friends for additional apartment size.

5

0 500 1,000

Apartment size (square feet)


The Marginal Rate of Substitution

Indifference curves describe tradeoffs

• How much of one good you are willing to give up for one more unit of

another good

• The slope of the indifference curve captures this tradeoff

We call this slope the marginal rate of substitution

Describes the rate at which one is willing to trade off or substitute

exactly 1 unit of good X for more of good Y, and be equally well

off.

X

YMRSXY


Figure 4.5 The Slope of an Indifference Curve is the

Marginal Rate of Substitution

Burritos

A

Slope = –2

B

Slope = –0.5 U

As you move down an indifferencecurve, you experience a diminishing

marginal rate of substitution

Lattes


The Marginal Rate of Substitution and Marginal Utility

Consider point A from the previous figure

Sarah is willing to give up one latte (X) to gain two burritos (Y), vice versa;

What does this mean in terms of the change in Sarah’s level of utility?

The change in utility is zero... she is just as well off! Rearranging,

and finally:

0

burritos

lattes

2XY

QYMRS

X Q

lattes lattes burritos burritosU MU Q MU Q

burritos burritos lattes lattesMU Q MU Q

burritos lattes

lattes burritos

XY

Q MUMRS

Q MU


The Marginal Rate of Substitution and Marginal Utility

The MRS between two goods is equal to the inverse of the goods’

marginal utilities:

Observing the tradeoffs that consumers make provides insight as to the

relative marginal utilities of goods!

What does it mean if the slope of an indifference curve is steeper?

Flatter?

• Steeper curves imply the consumer is willing to give up a lot of Y to get one

unit of X, or could trade 1 unit of X for a lot of good Y

• Flatter curves imply the consumer would require a large increase in good X

to give up one unit of the good Y, or could trade 1 unit of Y for a lot of good X

burritos lattes

lattes burritos

Y Xlb XY

X Y

Q MU Q MUMRS or MRS

Q MU Q MU


Figure 4.6 The Steepness of Indifference Curves


The Curvature of Indifference Curves: Substitutes and Complements

The shape of indifference curves reveals information about the relationship

between products

• Relatively straight indifference curves describe goods that are more easily

substitutable for one another

• Indifference curves that are more convex to the origin describe goods that are

more complementary to one another

To illustrate, consider extreme cases

i. Perfect substitutes are goods that the consumer will trade at a fixed rate and

receive the same level of utility (MRS is constant)

ii. Perfect complements are goods that the consumer must consume in a fixed

proportion


Perfect substitutes

Consider a typical consumer’s

preferences for 1- and 2-liter soda bottles

This consumer should be willing to trade

one 2-liter bottle for two 1-liter bottles no

matter how much of each he or she has

MRS is constant in this case

0

1

U1

2

3

4

2 864

U4U3U2

1-liter bottles of

root beer

2-liter bottles of

root beer


Perfect complements

Alternatively, consider preferences for

hotdogs and hotdog buns

Most consumers will prefer to consume

these goods in constant proportion

Consider point A ; this consumer has two

hotdogs and two buns

Adding another hotdog bun (bundle B )

will not increase utility

The consumer needs another hotdog as

well (bundle C ) if utility is to increase0

1 U1

2

3

1 32

U3

U2

A B

C

Hotdog buns

Hotdogs


Figure 4.8 The Curvature of Indifference Curves


Figure 4.11 The Same Consumer Can Have Indifference

Curves with Different Shapes

Initially, for low levels of utility

(UA), bananas and strawberries

might be substitutes.

As utility increases (UB), the

consumer might prefer a variety

of fruit in their diet more than

initially.

The Consumer’s Income and the

Budget Constraint 4.3

The budget constraint is a curve that describes the entire set of

consumption bundles a consumer can purchase when spending all of

their income. It is generally plotted alongside indifference curves.

• For two goods (X and Y), mathematically:

To find the slope of the budget constraint, solve for QY

Returning to the burrito/latte example, and setting income to $50, the

price of lattes to $5, and the price of burritos to $10 yields

Or, graphically,

YYXX Q + PQ= P Income

QP

P

P= Q x

Y

X

Y

Y Income

Q= Q XY2

15



Figure 4.14 The Budget Constraint

Burritos

BIPy

4 Infeasible

C3

Px2 Slope = - = −5/10= − 1/2Py

Feasible1

A

0 2 4 6 8I

Px

Lattes

= 5

= 10

Slope is negative because purchasing more lattes means

less income for Burritos.

Why does thebudget constraintslope downward?



Factors that Affect the Budget Constraint’s Position

The slope and position of the budget constraint are a function of two

factors: income and relative prices

1. Changes in income shifts the budget constraint by changing the intercepts

2. Changes in the price of one good pivots the budget constraint by changing

the slope

Consider again the budget constraint for burritos and lattes. The graphs

on the next slide represent the following changes:

(a) Doubling of the Price of Lattes

(b) Doubling of the Price of Burritos

(c) Reduction in Income by 1/2



Figure 4.15 The Effects of Price or Income Changes on the

Budget Constraint

(a) (b) (c)

Burritos Burritos BurritosOld budget Old budget Old budgetB B B

55 5constraint constraint constraintNew budget New budget

New budgetconstraint with higher constraint with higher 44 4constraint withprice for lattes price for burritoslower income

33 3B' B'Loss of feasible Loss of feasible Loss of feasible

bundlesbundles bundles22 2

11 1 Feasible FeasibleFeasiblebundles bundlesbundles A' A A A' A

0 00 2 4 6 8 10 2 4 6 8 10 2 4 6 8 10

Lattes Lattes Lattes



Nonstandard Budget Constraints

Quantity discounts

• Sometimes, consumers may secure a discounted price if a minimum quantity of

a good is purchased (e.g., buy two, get one free)

• This results in a kink in the budget constraint

Ex: Income = $100; Ppizza = $10 and Pminute = $0.10

• Initially, the consumer could consume 10 pizzas or 1,000 phone minutes if spent

all of their income on either product; Result is normal linear budget constraint

‒ Introduce a quantity discount of $.05 per minute for every minute used over 600

‒ Result is a kink at 600 minute (and 4 pizzas) because every minute over 600

now only costs $0.05 compared to $0.10 originally

• Graphically,



Figure 4.16 Quantity Discounts and the Budget Constraint

Phoneminutes

1,400

5 cents/minuteInfeasible

Feasible1,000

60010 cents/minute

Feasible

0 4 10 Pizzas



Nonstandard Budget Constraints

Quantity limits

• Alternatively, there may be limits on how much of a good can be purchased

(e.g., gasoline in the 1970s)

Ex: Income = $100; Ppizza = $10 and Pminute = $0.10

• Now, instead of a discount after 600 minutes the phone company puts a cap

at 600 minutes so his phone will not work after the 600th minute

‒ Result is a kink in the opposite direction as before at 600 minutes

• Graphically,



Figure 4.17 Quantity Limits and the Budget Constraint

Combining Utility, Income, and Prices:

What Will the Consumer Consume? 4.4

The concepts of utility and indifference curves describe consumer

preferences; the budget constraint describes which bundles are feasible

Combining these concepts, we can begin to understand consumer

choices

Solving the Consumer’s Optimization Problem

Consumers face a constrained optimization problem

• Maximize utility, subject to income and market prices

The optimal choice can be interpreted most easily using a graph



Utility Maximization

A

Good X

Good Y

U1

BC*

U*

U2

With one budget constraint,

search for indifference curve

that maximizes utility



Tangency is the key to finding the optimal bundle, and occurs

• where the slope of the indifference curve is equal to the slope of the budget

constraint

‒ i.e. when the marginal rate of substitution is equal to the price ratio

Mathematically,

constraintbudget of Slopecurve ceindifferen of Slope

Y

X

Y

XXY

P

P

MU

MUMRS

Y

X

Y

X

P

P

MU

MU



What does this imply? Rewriting the tangency condition yields

The consumer finds the consumption bundle that provides the most

benefit on a cost-adjusted basis

Occurs when marginal utility per dollar spent is • equalized across all products

What does it imply if ?

Marginal Utility per dollar spent on good ‒ X is more than good Y. Getting • more utility per dollar from X so you should consume more of good X until the MUX decreases until the ratio is equal

Y

Y

X

X

Y

X

Y

X

P

MU

P

MU

P

P

MU

MU

Y

Y

X

X

P

MU

P

MU



Implications of Utility Maximization

What if two consumers have different preferences?

• Will they have the same MRS at their optimal bundles?

Yes! Because they face the same ratio of prices!



Figure 4.19 The Consumer’s Optimal Choice

Gum

UM

J

UJ

Budget constraintM

iTunes

Meg prefersiTunes over gum

Jack prefersgum over iTunes Although they have different

optimal consumption bundles,

the MRS for both are the same

at points J and M because they

face the same prices

Conclusion 4.5

This chapter introduced the underlying mechanisms behind

consumer choice

• Preferences

• Prices and income

In Chapter 5, we make the link between consumer behavior and

individual and market demand

Individual and Market Demand

5

Introduction 5

Chapter Outline

5.1 How Income Changes Affect an Individual’s Consumption Choices

5.2 How Price Changes Affect Consumption Choices

5.3 Decomposing Consumer Responses to Price Changes into Income and

Substitution Effects

5.4 The Impact of Changes in Another Good’s Price: Substitutes and

Complements

5.5 Combining Individual Demand Curves to Obtain the Market Demand

Curve

5.6 Conclusion

Introduction 5

With the consumer choice framework in place, we now link

consumer decisions with individual and market demand

These links help determine:

• Why shifts in tastes affect prices

• What benefits producers offer consumers

• How income and wealth affect purchase patterns

• What determines how consumers respond to price changes

How Income Changes Affect an

Individual’s Consumption Choices 5.1

The income effect is the change in optimal consumption choices

associated with a change in income (or purchasing power),

holding relative prices constant

Is higher income associated with higher consumption of goods?

It depends!

For normal goods, higher income is associated with rising

consumption

• For instance, consider Vacations and Basketball Tickets, both of

which are considered normal goods



Figure 5.1 A Consumer's Response to an Increase in

Income When Both Goods Are Normal

VacationsIncome

rises

B

AQv

U2

U1

BC1 BC2

Baseball TicketsQb Q’b

Q’v



The income effect is the change in optimal consumption choices

associated with a change in income (or purchasing power),

holding relative prices constant

Is higher income associated with higher consumption of goods?

It depends!

Alternatively, for inferior goods, higher income is associated with

falling consumption

• Consider boxed macaroni and cheese (an inferior good) vs. steak (a

normal good)



Figure 5.2 Consumer's Response to an Increase in Income

When One Good is Inferior

Quantity ofMac and

cheese

AQmac

B

IncomeU1risesU2

BC1 BC2

Quantityof steak

Qs

Q’mac



Income Elasticities and Types of Goods

Chapter 2 introduced the concept of elasticity

• Income elasticity describes the response of demand to changing income

‒ Specifically, the percentage change in quantity consumed associated

with a percentage change in income

Mathematically,

where I is income and Q is the quantity of a good demanded

The income effect is given by

Q

I

I

Q

II

QQ

I

QE D

I

/

/

%

%

I

Q



Income Elasticities and Types of Goods

Thus, the sign of the income elasticity is the same as the income effect

If , the good in question is a normal good

If , the good in question is an inferior good

00

I

QE D

I

00

I

QE D

I



There are two additional sub-types of goods that are common, both of

these are classified as normal goods because as income increases,

the quantity demanded for them increases as well and vice versa

• Necessity goods: normal goods for which income elasticity is between 0

and 1

‒ Examples: water consumption, electricity, clothing, etc…

• Luxury goods: normal goods for which income elasticity is greater than 1

‒ Examples: vacation homes, jewelry, expensive steaks, etc…



Tracing the optimal bundle of goods chosen as income increases

results in the income expansion path

• Helps determine whether a good is normal or inferior, but only two

goods can be represented

• Can’t directly observe income levels on the curve because both axes

represent quantities of goods

A more common way to describe the consumption-income

relationship is with an Engel curve

• Shows the relationship between quantity consumed of one good and

consumer income



Figure 5.3 The Income Expansion Path



Figure 5.4 An Engel Curve Shows How Consumption Varies

with IncomeIncome/ week

Engel$35curve

E30

25 D

20 C

15 B

10 A

5

0 Bus1 2 3 4 5 6 7 8rides

Income / week

Engel$35 curve

E30

D25

C20

B15

A10

5

0 1 2 3 4 5 6 7 8 Bottledwater

9

At point Drides become

inferior

Bottled water is normal at all income levels

How Price Changes Affect

Consumption Choices 5.2

Just as income affects consumer choices, changes in relative prices—

holding income constant—also affects these choices

Deriving a Demand Curve

• Demand curves define a relationship between quantity demanded

and price

• To derive a demand curve, we must understand how a consumer

responds to a change in price

• By changing one price on an indifference curve—budget constraint

map, we can observe changes to consumer choices and then build

the demand curve for an individual using these observed changes

• The observed price represents the maximum willingness to pay for

the last unit consumed



Figure 5.7 Building an Individual's Demand Curve

Mountain DewPG = 4 PG = 1(2 liter bottles) Income = $20

PG = $1PMD = $2

PG = 210

432 U1U3 U2

0 3 5 8 14 20

Quantity of grape juice(1 liter bottles)

Price ofgrape juice($/bottle)

Carolyn’s$4 demand for

2 grape juice1

03 8 14

Quantity of grape juice(1 liter bottles)

10



Shifts in the Demand Curve

When consumer preferences, income, or the prices of other goods

change, the demand curve will shift

Consider the example of Mountain Dew and grape juice from the

previous figure

• Imagine the consumer (Caroline) prefers the taste of Mountain Dew, but had

previously limited consumption due to worries about high fructose corn syrup

• After hearing advertisements from the Corn Refiners Association claiming

corn syrup is identical to cane sugar, her fears are reduced

What might happen to the demand for grape juice?

‒ In order to consume more Mountain Dew, she might reduce her consumption of

grape juice



Quantity ofMountain Dew

(2 liter bottles)

10

65.5

4

PG = 4 PG = 2 PG = 1

0 2 6 9 20

Quantity of grape juice

(1 liter bottles)

Price of

grape juice($/bottle)

$4 D2

2D11

0 2 6 9

Quantity of grape juice

(1 liter bottles)

(a) Caroline’s indifference curves for grape juice flatten when her preference for grape juice decreases relative to her preference for Mountain Dew. At each price level, she now consumes fewer bottles of grape juice.

(b) Because she purchases fewer bottles of grape juice at each price point, Caroline’s demand curve for grape juice shifts inward from D1 to D2.

PG = 4 PG = 1

PG = 2

U1U3 U2

Figure 5.8 Preference Changes and Shifts in the Demand

Curve

Decomposing Consumer Responses to Price

Changes into Income and Substitution Effects 5.3

When the price of a good changes relative to another, two things happen

1. One good becomes relatively more expensive, and the other relatively less

2. The total purchasing power of a consumer’s income changes

The substitution effect refers to the change in consumption choices

resulting from a change in relative prices

• Always negative; when the price of one good relative to another increases,

consumption of the former falls, and vice versa

The income effect refers to the change in consumption choices

resulting from a change in purchasing power

• This is the same income effect from Section 5.1

• Can be negative or positive (inferior or normal goods)



Figure 5.9 The Effects of a Fall in the Price of Basketball

TicketsConcertTickets

B6Total

Aeffect 5U2

U1

BC1 BC2

0 Basketball3 5tickets

Total effect



The total effect of a change in a price is the sum of the

substitution and income effects

• The total effect is simply the observed change in consumption of a

good after a price change

Total Effect = Substitution Effect + Income Effect




Isolating the Substitution Effect

• Determine the bundle of goods that would have been chosen

at the new price while maintaining utility experienced before

the price change

• Graphically: on the next slide

‒ To do this for a fall in the price of basketball tickets, shift the new

budget constraint (BC2) inward until it is tangent with the oldindifference curve (BC′)

‒ Movement along the original indifference curve (A to A′)



Figure 5.10 Substitution Effects and Income Effects for Two

Normal Goods(a)

ConcertTickets

B6

A5

U2

A′3

U1 BC2BC′BC1

0 Basketball3 4 5Tickets

Incomeeffect

Total effect(+ 1 concert ticket )

Substitutioneffect

Substitution effect Income effect

Total effect (+ 2 basketball tickets)

(b)(c)




Isolating the Income Effect

• The change in quantities demanded due to the changes in the

consumer’s purchasing power after the change in prices.

• When the price of basketball tickets decrease, the consumer

can afford to purchase a larger bundle than before.

‒ Represented by the change in the quantity of goods consumed

from bundle A’ (after the substitution effect) to bundle B

‒ Easy calculation: total effect minus the substitution effect



Three steps to computing substitution and income effects associated

with a price change. Starting with a consumer at an optimal bundle A

1. Draw the new budget constraint and find the new optimal bundle (B )

‒ A price change for one of two goods rotates or pivots the constraint

2. Draw a line parallel to the new budget constraint, but tangent to the old

indifference curve; determine the optimal bundle on the old curve

associated with this theoretical budget constraint (A′ )

3. The substitution effect is the difference in quantities between A and

A′ and the income effect is the difference in quantities between A′and B



What Determines the Size of the Substitution and Income Effects?

Curvature1. : The size of the substitution effect depends on the

curvature of indifference curves

What does it mean when an indifference curve is relatively

straight?

The ‒ 2 goods are relatively substitutable

Is the substitution effect larger or smaller along a straighter

indifference curve?

Larger, More substitutable = Larger substitution effect‒

Quantity consumed before the price change2. : The income effect

increases with the amount spent on a good before a price change

Why does the income effect increase with the amount spent on a

good?

The more you can get from trading off consumption of that good



Example of the Substitution and Income Effects for an Inferior Good

It is important to see how the income and substitution effects are opposed

to one another with an inferior good.

Consider a consumer choosing bundles of steak and ramen noodles

• Suppose the price of ramen noodles (an inferior good) falls

• Total effect followed by Income and Substitution effects graphically



Figure 5.12 A Fall in the Price of an Inferior Good



Figure 5.13 Substitution and Income Effects for an Inferior

Good

Changes:1. Price of ramen noodles has decreased

‒ Sub. Effect positive

2. Relative price of steak has increased‒ Sub. Effect negative

3. Relative Income has increased‒ Income effect positive for steak

(normal good) and negative for ramen (inferior good)

The income effect dominates the substitution effect for steak

The substitution effect dominates the income effect for ramen noodles.

(a)

Steak

Total effect(more steak) B

U2IncomeA

effect

A′

Substitutioneffect U1

BC1 BC2BC′

RamenIncomeTotal effect noodles

effect(more ramen noodles)

Substitution effect

(b)(c)



Giffen goods: are goods for which quantity demanded increases

as price rises

Inferior goods, but the income effect outweighs the substitution effect•

When the price of a • Giffen good drops, the substitution effect (which

acts to increase demand) is smaller than the income effect

Results in an upward sloping demand curve!‒

Economists sometimes question whether Giffen goods actually

exist

The few examples with humans tend to focus on very poor •

households and commodity crops (e.g., rice and potatoes)



Figure 5.14 A Change in the Price of a Giffen Good



Simple Rules about Income and Substitution Effects

The Impact of Changes in Another Good’s

Price: Substitutes and Complements 5.4

A Change in the Price of a Substitute Good

When the price of a substitute good increases, we expect

consumption of the primary good to increase

• Consider Pepsi-Cola and Coca-Cola



Figure 5.15 When the Price of a Substitute Rises, Demand

Rises

05

Pepsi

Coke

20

A

B

20

15

10

5

U1

U2 BC1BC2

Pepsi consumption

falls

Coke consumption rises

At original prices, this consumer purchases 15

bottles of Pepsi and 5 bottles of Coke

When the price of Pepsi doubles, Coke

consumption increases by 100% (to 10 bottles),

and Pepsi consumption falls by 67% (to 5 bottles)

Coke consumption rose when the price of Pepsi

rose, signify that they are substitutes

10



A Change in the Price of a Complementary Good

When the price of a complement increases, we expect

consumption of the primary good to decrease

Consider • ice cream and hot fudge



Figure 5.16 When the Price of a Complement

Rises, Demand Decreases

0

Ice cream(gallons)

Hot fudge(quarts)

50

A

B

20 30 50

25

20

15U1U2

BC1

BC2Ice cream

consumptionfalls

Hot fudge consumptionfalls

At original prices, this consumer

purchases 20 tubs of ice cream and

30 jars of hot fudge.

When the price of ice cream

doubles, consumption of ice cream

falls by 25% (20 to 15 tubs), and

consumption of hot fudge by 33%

(30 to 20 jars).

Hot fudge consumption decreased

when the price of ice cream

increased, signifying that they are

complements.



A Change in the Price of a Substitutes and Complements

When the price of a substitute good increases, we expect consumption

of the primary good to increase

• Recall the Pepsi-Cola and Coca-Cola example

When the price of a complement increases, we expect consumption of

the primary good to decrease

• Recall the ice cream and hot fudge example

These relationships help to explain the shifts in demand examined

in Chapter 2



Figure 5.17 Changes in the Prices of Substitutes or

Complements Shift the Demand Curve

Combining Individual Demand Curves to

Obtain the Market Demand Curve 5.5

The final step linking consumer theory to market demand

• Market demand is the horizontal sum of individual demand curves

• The market quantity demanded at each price is the sum of the

individual quantities demanded at each price

The market demand curve is found by summing horizontally the

individual demand curves

Consider the market for wireless speakers



Figure 5.19 The Market Demand Curve

(a)

B

A

Dmarket =Dyou + Dcousin

6 12

(b)

Dcousin

8

Price($/wireless Speaker set)

$52

40

20

Dyou

0 3

Quantity of wireless speaker sets

4

(c)



Mathematically connecting the individual and market demand

The difference in choke prices implies your demand function is the market

demand function for prices between $52 (cousin’s choke price) and $100

(your choke price);

• The market demand function applies to prices less than $52

)25.013()05.05(cousinyoumarket PPQQQ

market 18 0.3 for $52Q P P

5 0.5 for $52P P

PQ 3.018market

Conclusion 5.6

This chapter concludes our in-depth analysis of the

consumer side of the supply and demand model. We

• Examined how income and prices affect consumer choices

• Made the link between consumer theory and market demand

In Chapter 6 we begin a parallel in-depth examination of

producer behavior.

Documents

Consumer BehaviorConsumer Behavior 4. Introduction 4 Chapter Outline 4.1 The Consumer’s Preferences and the Concept of Utility 4.2 Indifference Curves 4.3 The Consumer’s Income