Introduction to Agricultural and Natural Resources Consumer Behavior

Introduction to Agricultural and Natural Resources Consumer Behavior and Market Demand FREC 150 Dr. Steven E. Hastings

Consumer Behavior and Market Demand • This Outline Cover Chapter 3, 4 and 5 in Penson et al. • Major Topics – The Concept of Utility – Model of Consumer Choice • Important Concepts – Budget Line, Indifference Curve and Maximizing Utility – Individual Demand Curve – Market Demand • Important Terminology • Factors that Shift – Engel Curve – Price and Income Elasticity

The Concept of Utility • The Concept of Utility – Utility is “satisfaction” from consuming or using a good or service (or a bundle of good and services). – Utility varies by consumer or user. – As more of a good is consumed, • Total Utility increases • Marginal Utility ( Total Utility / 1 Unit Consumed) – See Table 3 -2 and in the text; plot the data! – Illustrates the “law of diminishing marginal utility”.

Total and Marginal Utility TU – increases at A decreasing rate MU – change in TU / change in hamburgers MU - decreases

Figure 3– 1 a Total utility continues to increase as the number of hamburgers consumed increases, at least up to 11 hamburgers. At this point, total utility is maximized. Beyond 11 hamburgers, total utility decreases (A). Marginal utility declines as Sue increases her consumption of hamburgers (B). Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Figure 3– 1 b Total utility continues to increase as the number of hamburgers consumed increases, at least up to 11 hamburgers. At this point, total utility is maximized. Beyond 11 hamburgers, total utility decreases (A). Marginal utility declines as Sue increases her consumption of hamburgers (B). Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Marginal utility goes to zero at the peak of the total utility curve Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

• Consumer Choice – The basic problem is how to allocate a fixed, limited budget among various goods and services to maximize ones’ utility. – Economists use a “model” of consumer theory. – Assumptions: 1) people are rational, 2) people can “rank” goods and services, and 3) income (budgets) are limited.

Consumer Behavior and Demand • Concepts of Consumer Theory – Indifference Curve(s) – all combinations of two goods that provide the same level of satisfaction. Each curve is a different level of satisfaction (utility). – A Budget Line (Constraint) – a line connecting all combinations of two goods that the consumer can buy with a fixed budget. Prices of goods are fixed, initially.

The two indifference curves here can be thought of as providing 200 and 700 utils of utility. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

One would normally expect a number of additional isoutility or indifference curves. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Which bundle would you prefer more…bundle M or bundle Q? Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

The answer is that this we would be indifferent because they give us the same utility. The ultimate choice will depend on the prices of these two products. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

What about the choice between bundle M and bundle P? Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

We would prefer bundle P over bundle M because it gives us more utility or satisfaction. The question is whether we can afford to buy 5 tacos and 5 hamburgers! Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Example of a Budget Constraint Table 3– 3 Example of a Budget Constraint Each of these combinations represent a point on the budget line… Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Indifference Curves Characteristics of “nomal shaped” IC’s: convex to the origin, do not cross, and require only “ranking”

Line BA is the original budget line. It says that Carl can afford either 10 tacos or two hamburgers a week with his $5 weekly budget. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

The original budget line would shift in to line FG if Carl’s available income fell in half (or both prices doubled). It would shift out to line ED if Carl’s income doubled (or both prices fell in half). Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

The budget line would shift out to line AE if the price of tacos fell in half or shift in to line AF if taco prices fell in half. Note the price of hamburgers did not change! Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Finally, the budget line would shift out to line BD if the price of hamburgers fell in half, or in to line BG if the price of hamburgers doubled. Introduction to Agricultural Economics, 6 e Penson | Capps | Rosson | Woodward Copyright © 2015, 2010 by Pearson Education, Inc. All Rights Reserved

Budget Constraint (Line)

Maximizing Utility • Assume a consumer is rational and want to get the greatest satisfaction possible from his/her budget. • Combine a set of indifference curves and a budget. • Utility is maximized at the combination of goods where the budget line is tangent to the highest (farthest to the right) indifference curve. • Mathematically speaking, the slope of the budget line is equal to the slope of the indifference curve. • Referred to as consumer’s (Joe’s or Mary’s) “consumer equilibrium”.

Consumer Equilibrium

Price and Budget Changes Price change, ceteris paribus Budget change, ceteris paribus

Consumer Behavior and Demand • An Individual Demand Curve – Fundamental concept of economics! – Shows the maximum quantities of a good and individual is willing and able to buy at various prices in a given market at a point in time, ceteris paribus. – Ceteris paribus – other things held constant (prices of other goods, tastes and preferences (indifference curves), budget. – Allow the price of one good to change and record and plot the resulting price and quantities. – Reflects “ law of demand”.

Deriving a Consumer’s Demand Curve

Individual Demand Possibly, the most famous of all microeconomic concepts. Iluustrate’s the Law of Demand” Shows the maximum quantities of a good and individual is willing and able to buy at various prices in a given market at a point in time, ceteris paribus.

Consumer Behavior and Demand • A Market Demand Curve – Market Demand Curve is the various quantities of a good that all consumers in a market at a point in time are willing and able to buy. – Size of a “market” varies – Newark market for pizza, United States’ market for cars, global market for…. – Conceptually, the market demand curve is the horizontal summation of individual demand curves, i. e. , pick a price and sum the quantities.

Market Demand Curve

Market Demand Curve Important terminology – “a change in quantity demanded” – a movement along a demand curve in response to price change – “a change (or shift) in demand” – a shift (in or out) of the demand curve in response to change in preferences, income, expectations, prices of related goods, income, population – Subtle wording difference, but different meaning.

Consumer Behavior and Demand

Market Demand “Shifters” • Factors that Shift the Demand Curve – Size of the Population (aka, “size of market”) – Tastes and Preferences (see Penson et al, page 61) – Income (budget lines) • For most goods, increased income means increase in demand (shift out). • For some goods, increased income means, decrease in demand (shift in). – Prices of Related Goods • Effect depend on relationship of goods – complements or substitutes. • Substitutes – Coke and Pepsi (for many people). • Complements – peanut butter and jelly, bacon and eggs, etc. – Expectations – snow storm is coming!

Elasticity (ies) of Demand • Elasticity – Numerical measure of the “responsiveness” of quantity of a good demanded to a change in the price of the good (price elasticity) or income (income elasticity). • Price Elasticity of Demand – Definition – numerical measure of the “responsiveness” of quantity of a good demanded to a change in the price of the good. – Calculation – pick two points on a demand curve (D and C) - page 56 in text. – It is the “percent change in quantity divided by the percent change in price. ” – Interpretation – if the price of a good changes, do consumers buy a little more (or less) or a lot more (or less).

Values for Ed – Possibilities • Ed is always negative (why? ), so ignore the negative sign. • Inelastic Demand Ed < 1 • Unitary Elasticity Ed = 1 • Elastic Demand Ed >1

Factors that Affect Ed – Factors that affect Price Elasticity • Substitutes – the more substitutes, the higher Ed • Alternative uses – the more uses, the higher the Ed • The larger the expenditure as a part of consumers’ budget, the higher the Ed

Effect of ED on Total Revenue – Why is price elasticity of goods and services important?

Engel Curve • Engel Curve – Similar to a demand curve, but shows the change in quantity of a good demanded in response to a change in income. – Plot the tangency points on different budget lines and indifference curves at highest levels of satisfaction.

Derived from Budget Changes • An Engel Curve is derived by increasing a consumer’s budget, and noting the quantity of a good that is consumed. Budget change, ceteris paribus

Graphically, • Engel Curve for Food Purchased • Engel Curve for Clothing Purchased Income

Consumer Behavior and Demand • Income Elasticity of Demand – Definition – numerical measure of the “responsiveness” of quantity of a good demanded to a change in the consumer’s income – Calculation – pick two points on an Engel Curve (I 1, Q 1 and I 2, Q 2). – It is the “percent change in quantity divided by the percent change in price. ” – Interpretation – if income changes, do consumers buy a little more (or less) or a lot more (or less) of a good.

Graphically, • Engel Curve for Food Purchased • Engel Curve for Clothing Purchased Income

Income Elasticity – Possibilities • Income elasticity can be positive or negative, so the sign is important. • Normal Good • Superior Good • Inferior Good Income Elasticity is between 0 and 1 Income Elasticity is > 1 Income Elasticity is < 0

– Why is this important? • From the USDA Web Site (2003):

Consumer Behavior and Demand • Summary – The concept of consumer demand is used to model and measure consumer behavior in our economic system. – It is a fundamental part of microeconomics. • Lecture Sources: Text and Miscellaneous Materials • For more information, see: – – Text Wikipedia - http: //en. wikipedia. org/wiki/Consumer_theory Wikipedia - http: //en. wikipedia. org/wiki/Price_elasticity_of_demand Wikipedia http: //en. wikipedia. org/wiki/Income_elasticity_of_demand

Assignment 4 - Figure A

Assignment 4 – Figure B Note axis change!