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Demand and Consumer Behaviour Economics
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Dr. Rama PalHSS, IITB
Demand and Consumer Behaviour
Choice and Utility Theory
Utility means satisfaction
Utility is a scientific construct that economists use to understand how rational consumers make decisions
In the theory of demand, we assume that people maximize their utility, which means that they choose the bundle of consumption goods that they most prefer
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Marginal Utility
Marginal means additional or extra.
Marginal utility denotes the additional utility you get from the consumption of an additional unit of a commodity
Law of Diminishing Marginal Utility It states that, as the amount of a good consumed
increases, the marginal utility of that good tends to decline
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Example: Consumption of Ice-cream
Q TU MU
0 0
1 4 4
2 7 3
3 9 2
4 10 1
5 10 0
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Total Utility: Consumption of Ice-cream
0123456789
10
0 1 2 3 4 5
Total Utility
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Marginal Utility: Consumption of Ice-cream
0
1
2
3
4
5
1 2 3 4 5
Marginal Utility
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Relation between TU and MU
Total utility of consuming a particular amount is equal to the sum of the marginal utilities up to that point
TU is maximum when MU is zero.
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Equimarginal Principle
Assumption: consumer maximizes utility
Equimarginal principle: It states that a consumer will achieve maximum satisfaction or utility when the marginal utility of the last rupee spent on a good is exactly the same as the marginal utility of the last rupee spent on any other good
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Equimarginal Principle
The common marginal utility per rupee of all commodities in consumer equilibrium is called the marginal utility of income. It measures the additional utility that would be gained if the consumer could enjoy an extra rupees worth of consumption
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Equimarginal Principle
Why demand curves slope downward
A higher price for a good reduces the consumers desired consumption of that commodity
)(...2
2
1
1 incomeofrupeeperMUP
MUP
MUP
MUn
n
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Examples
Allocation of money
Allocation of time
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Behavioural Economics
Calculation of marginal utility
Consumers are reasonably consistent in their tastes and actions
Irrational or inconsistent behaviour
Asymmetric information
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The Indifference Curve The points on the indifference curve represent consumption
bundles among which the consumer is indifferent; all are equally desirable
X
Y
A=(X1,Y1)
B=(X2,Y2)
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The Indifference Curve
Marginal rate of substitution slope of indifference curve = Y/ X = -MUX/MUY
Diminishing MRS (convexity): the more you have of one of the goods the more you can give it up in exchange for other good
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Diminishing Marginal MRS
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve
8
3
A
3
7
B
1
MRS = 6
1MRS = 14
6
14
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Indifference Map
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve, I1
I2
C
B
A
D
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Indifference Map
Consumption bundles on IC which are farther from the origin are preferredMore is betterPreferences over Bads
There is an IC through each bundle
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Properties of Indifference Curves Indifference curves cannot cross
Indifference curves slope downwards and is convex to the origin
Indifference curves cannot be thick
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The Impossibility of Intersecting ICs
Quantityof Pizza
Quantityof Pepsi
0
C
A
B
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IC: Perfect Substitutes
Example: Red pencil and blue pencil
Red Pencil
Blue Pencil
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IC1
IC2
IC: Complements
Example: Tea and sugar
Tea
Sugar
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IC2
IC1
Problem # 1 Plot the indifference curves showing preferences
over consumption good, x and work, l. Here, your satisfaction goes up in x and down in work (i.e., you enjoy leisure).
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