Applied economics- Chapter 7- The consumer behavior
The standard economic model
Standard economic model-a classical theory of consumer behavior based on an assumption of
rational behavior
Assumptions of standard economic model:
-your limitation while purchasing goods is your income, the prices of goods and the value they
represent. Considering this consumers choose a bundle of goods that best suits your needs and
maximizes value.
Assumptions in summary:
• Buyers (or economic agents as they are sometimes referred to) are rational.
• More is preferred to less.
• Buyers seek to maximize their utility.
• Consumers act in self-interest and do not consider the utility of others.
1. Value
Value- the worth to an individual of owning an item represented by the satisfaction derived from
its consumption.
Utility- the satisfaction derived from consumption
We can measure value based on:
-the amount consumers are prepared to pay. The amount that buyers are prepared to pay for a
good, tells us about the value they place on it.
2. Total and Marginal utility
Marginal utility- measures the additional to total utility as a result of the consumption of an extra
unit. The marginal utility of consuming one more piece of good is often smaller then of consuming
previous piece. The marginal utility can be negative if you over consume the good and don’t want
to continue consuming it.
Diminishing marginal utility- the more a consumer has of a given commodity the smaller the
satisfaction gained from consuming each extra unit.
As consumption of a good rises, total utility will rise at rst but at a slower rate until some point at
which the consumer becomes satiated (has had enough) after which point total utility will fall and
marginal utility will be negative.
Marginal rate of substitution- the rate at which consumer is willing to trade one good for
another. This depends on the marginal utility of both goods. More generally, the marginal rate of
substitution equals the marginal utility of one good divided by the marginal utility of the
other good.
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, 3. A ordability
People consume less then desired because their spending is constrained, or limited by their
income.
Budget constrains- the limit on the consumption bundles that a consumer can a ord. The slope of
the budget constraint measures the rate at which the consumer can trade one good for another.
Slope=relative price
From point A to point B, the vertical distance is 500 litres, and the horizontal distance is 100
pizzas. Because the budget constraint slopes downward, the slope is a negative number – this
re ects the fact that to get one extra pizza, the consumer has to reduce his consumption of cola
by ve litres. In fact, the slope of the budget constraint (ignoring the minus sign) equals the
relative price of the two goods – the price of one good compared to the price of the other. A
pizza costs 5 times as much as a litre of cola, so the opportunity cost of a pizza is 5 litres of cola.
The budget constraint’s slope of 5 re ects the trade-o the market is o ering the consumer: 1
pizza for 5 litres of cola.
4. Preferences- what consumer wants
Indi erence curve- a curve that shows consumption bundles that give the consumer the same
level of satisfaction
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fl ff ff ff
The standard economic model
Standard economic model-a classical theory of consumer behavior based on an assumption of
rational behavior
Assumptions of standard economic model:
-your limitation while purchasing goods is your income, the prices of goods and the value they
represent. Considering this consumers choose a bundle of goods that best suits your needs and
maximizes value.
Assumptions in summary:
• Buyers (or economic agents as they are sometimes referred to) are rational.
• More is preferred to less.
• Buyers seek to maximize their utility.
• Consumers act in self-interest and do not consider the utility of others.
1. Value
Value- the worth to an individual of owning an item represented by the satisfaction derived from
its consumption.
Utility- the satisfaction derived from consumption
We can measure value based on:
-the amount consumers are prepared to pay. The amount that buyers are prepared to pay for a
good, tells us about the value they place on it.
2. Total and Marginal utility
Marginal utility- measures the additional to total utility as a result of the consumption of an extra
unit. The marginal utility of consuming one more piece of good is often smaller then of consuming
previous piece. The marginal utility can be negative if you over consume the good and don’t want
to continue consuming it.
Diminishing marginal utility- the more a consumer has of a given commodity the smaller the
satisfaction gained from consuming each extra unit.
As consumption of a good rises, total utility will rise at rst but at a slower rate until some point at
which the consumer becomes satiated (has had enough) after which point total utility will fall and
marginal utility will be negative.
Marginal rate of substitution- the rate at which consumer is willing to trade one good for
another. This depends on the marginal utility of both goods. More generally, the marginal rate of
substitution equals the marginal utility of one good divided by the marginal utility of the
other good.
fi
, 3. A ordability
People consume less then desired because their spending is constrained, or limited by their
income.
Budget constrains- the limit on the consumption bundles that a consumer can a ord. The slope of
the budget constraint measures the rate at which the consumer can trade one good for another.
Slope=relative price
From point A to point B, the vertical distance is 500 litres, and the horizontal distance is 100
pizzas. Because the budget constraint slopes downward, the slope is a negative number – this
re ects the fact that to get one extra pizza, the consumer has to reduce his consumption of cola
by ve litres. In fact, the slope of the budget constraint (ignoring the minus sign) equals the
relative price of the two goods – the price of one good compared to the price of the other. A
pizza costs 5 times as much as a litre of cola, so the opportunity cost of a pizza is 5 litres of cola.
The budget constraint’s slope of 5 re ects the trade-o the market is o ering the consumer: 1
pizza for 5 litres of cola.
4. Preferences- what consumer wants
Indi erence curve- a curve that shows consumption bundles that give the consumer the same
level of satisfaction
flfiffff
fl ff ff ff
