Consumer behavior and Utility Maximization Income Effect

When price of any good rises it tends to

CONSUMER – is the one who demands and
decrease real income and causes income effect
consumes goods and services
Real income means the actual amount of goods
PRODUCER – are the passive agents
and services that your money income can buy
GOODS – refer to anything that provides
CONSUMER SURPLUS – is a measure of the
satisfaction to the needs, wants and desires of
welfare we gain from the exchange of goods.
the consumers
Consumer surplus is the difference between
SERVICES - are intangible economic activities
the total amount that we actually pay for that
CONSUMER GOODS – goods that yield
good or service
satisfaction directly to any consumer
INDIFFERENCE CURVE – is a line that shows
Essential or Necessity Goods VS. Luxury Goods
combinations of goods among which a
ESSENTIAL OR NECESSITY GOODS - are goods
consumer is indifferent
that satisfy the basic needs of man.
BUDGET LINE or CONSUMPTION POSSIBILTY
LUXURY GOODS – are those which men may do
LINE - shows the various combinations of two
without, but which are used to contribute to
products that can be purchased by the
his comfort and wellbeing
consumer with his income, given the prices of
ECONOMIC AND FREE GOOD
the products
Economic Goods - are both useful and scarce. It
has value attached to it and a price has to be Demand and Supply Analysis
paid for its use. DEMAND - indicates how much of a good
FREE GOODS – are those goods which are consumers are willing and able to buy at each
abundant that there is enough of it to satisfy possible price during a given period
everyone's need without anybody paying for it - intention to buy/purchase goods
- willingness and ability to buy is critical to
Tastes and Preferences are determined by age, demand
income, education, gender, occupation, LAW OF DEMAND - says that quantity
customs and traditions as well as culture demanded varies inversely with price, other
UTILITY - means Satisfaction or pleasure. It things constant
refers to how consumers rank different goods • Higher the price, the smaller the quantity
and services demanded
UTILITY THEORY - it explains how satisfaction • Lower the price, the larger the quantity
or utility as consumers decline when we try to demanded
consume more and more of the same good at DEMAND ANALYSIS
particular point in time 1. Demand Schedule - a table shows the
* The benefit or satisfaction from consuming a relationship of prices and the specific
good or service is called utility quantities demanded at each of these price
Total utility - is the total benefit a person gets 2. Demand Curve - a graphical representation
from the consumption of goods showing the relationship between price and
MARGINAL UTILITY - is the change in total quantity demanded per time period
utility that results from a one-unit increase in • Change in quantity demanded - is represented
the quantity of a good consumed by a movement along the demand curve and can
* As the quantity consumed of a good increase, only be caused by a change in price
the marginal utility from consuming it • Change in demand - is represented by a
decreases -– we call this decrease in marginal rightward shift of the demand curve which is
utility as the quantity of the good consumed caused by a change in price of a substitute good
increases the principle of diminishing marginal 3. Demand Function - shows the relationship
utility between demand for a commodity and the
MARGINAL UTILITY - is simply the change in factors that determine or influence this
total utility divided by the change in quantity demand
QD = quantity demanded
* The utility-maximizing combination is called a
a = intercept of the demand curve at particular
consumer equilibrium
price
Substitution Effect b = slope of the demand curve
When price of good rises, consumers will c = price of the good at a particular time period
tend to substitute other goods
Individual Demand & Market Demand
Individual demand - refers to the demand of SUPPLY ANALYSIS
an individual consumer 1. Supply schedule – a table listing the various
Market demand - is the sum of the individual prices of a product & the specific quantities
demands of all consumers in the market supplied at each of these prices at a given point
in time
Forces that cause the demand curve to change: 2. Supply Curve - graphical representation
1. Taste or preference - pertain to personal showing the relationship between the price
likes or dislikes of consumers for certain goods sold or factor of production and the quantity
and services supplied per time period
2. Changing incomes - increasing incomes in of * The supply curve slopes upward from left to right
households raise the demand for certain goods indicating that price rises(falls) more (less) is supplied.
The upward slope indicates the positive relationship
or services or vice versa
between price and quantity supplied
Goods classified into 3 broad categories: 3. Supply Function - the quantity supplied is
(1) Normal goods - the demand increases when affected/influence by other factors which are
income increases and decreases when income price of the product, number of sellers, price of
decreases factor inputs, technology, business goals,
(2) Luxury goods - the demand increases when importations
income increases and decreases when income QS = f (products own price, number of sellers,
decreases price of factors input, technology)
(3) Inferior goods - the demand decreases QS= a + bP
when income increases and increases when
income decreases Supply and Quantity Supplied
3. Occasional or seasonal products - various • Change in quantity supplied - occurs if there
events or seasons in a given year also result to is a movement from one point to another along
a movement of the demand curve with the same supply curve. Affected by price only.
reference to particular goods • Change in supply – the entire supply curve
4. Population change - an increasing shifts leftward or rightward (price is constant)
population leads to an increase in the demand affected by technology, business goals etc)
for some types of goods or services and vice Individual Supply and Market Supply
versa Individual supply - refers to the supply of an
5. Substitute goods - goods that are individual producer
interchanged with another good. generally Market supply - is the sum of individual
offered at a cheaper price supplies of all producers in the market
Two (2) general relationships
1. Two goods are substitutes if an increase in Shifts of the Supply Curve
the price of one shifts the demand for the Determinants of supply other than the price of
other rightward (upward slope) the good:
2. Two goods are complements if an increase in 1. State of technology
the price of one shifts the demand for the 2. Prices of relevant resources - resources that
other leftward (downward slope) are employed in the production of the good in
6. Expectations of future prices - if buyers question
expect the price of a good or service to rise or 3. Prices of alternative goods - alternative
fall in the future, it may cause the current goods are those that use same resources
demand to increase or decrease employed to produce the good under
SUPPLY - indicates how much of a good consideration
producers are willing and able to offer for sale 4. Prices of goods that joint-in supply
per period at each possible price 5. Producer expectations - when a good can be
LAW OF SUPPLY - states that the quantity easily stored, expecting future prices to be
supplied is usually directly related to its price, higher may reduce current supply
other things constant 6. Number of producers in the market - since
• The lower the price, the smaller the quantity market supply sums the amounts supplied at
supplied each price by all producers, the market supply
• The higher the price, the greater the quantity depends on the number of producers in the
Supplied market
* As price increases, other things constant, a 7. Supply shifts to the right the supply increases
producer becomes more willing to supply the 8. Supply shifts to the left the supply decreases
good
 Disequilibrium Prices
Demand and Supply Create a Market DISEQUILIBRIUM - is the condition in the
* Demanders and suppliers have different market when plans of buyers do not match
views of price; plans of sellers
Demanders, consumers, pay the price * The forces behind the adjustment from
Suppliers, sellers, receive the price disequilibrium to equilibrium is known
MARKETS - Where the buyers and seller meets. as the price mechanism
- sort out the conflicting price perspectives Market Intervention
of individual participants – buyers and sellers. * Normally market intervention is in the form
EQUILIBRIUM - state of balance of price control which it can be a direct/indirect
* When the quantity consumers are willing price control
and able to pay equals the quantity producers * A direct price control is by enforcing the price
are willing and able to sell, the market reaches floors/ceilings policy while indirect price
equilibrium control is by imposing tax to increase prices or
* Market equilibrium meeting of supply giving subsidies to lower prices
and demand
Changes in Equilibrium Market Equilibrium
- Once a market reaches equilibrium, that price • Demand Equation QD = a-b(P)
and quantity will prevail until one of the • Supply Equation QS = a+b(P)
determinants of demand or supply changes • Equilibrium Condition QD = QS
Shifts of the Demand Curve • QD, QS and P is unknown, the parameter
* Given an upward-sloping demand curve, an in equations is a and the coefficient is b.
increase in demand leads to a rightward shift of Given this we can solve the equilibrium
the demand curve, increasing both the price (PE) and equilibrium quantity (QE).
equilibrium price and quantity
* Alternatively, a decrease in demand leads to
a leftward shift of the demand curve, reducing
both the equilibrium price and quantity
Market Disequilibrium
SURPLUS - condition in the market where the
quantity supplied is more the quantity
demanded (Downward pressure to price)
SHORTAGE - condition in the market in which
the quantity demanded is higher than the
quantity supplied at a given price (Upward
pressure to price)
Shifts of the Supply Curve
* An increase in supply: a rightward shift of the
supply curve reduces equilibrium price but
increases equilibrium quantity
* A decrease in supply: a leftward shift of the
supply curve increases equilibrium price but
decreases equilibrium quantity
* Given a downward-sloping demand curve, a
rightward shift of the supply curve decreases
price, but increases quantity
* A leftward shift increases price, but decreases
quantity

Effects of Changes in Both Supply and Demand