ECON 1110 Chapter Notes - Chapter 6: Jazz Club, Capital Market, Normal Good
27 May 2018
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Chapter 6 Household Behavior and Consumer Choice
The Determinants of Household Demand:
• Price of the product
• Income available to the household
• Household’s aout of auulated ealth
• Price of other products available to the household
• Household’s tastes and preferences
• Household’s epetatios aout futue ioe, ealth, ad pies
Budget constraint: limits imposed on household choice by income, wealth, and product prices
Choice set/opportunity set: the set of options that is defined and limited by a budget
constraint
Suppose Ann and Tom are two struggling grad students whose tuition is paid by the graduate
fellowships. The fellowships give them $200 each month to cover all their other expenses. To
siplif thigs, let’s assue that A ad Thoas sped their money on only two things: meals
a local Thai restaurant and nights out at a local jazz club. Their meals go for a fixed price of $20
per couple, and two tickets to the jazz club are $10.
The opportunity set is the shaded area in the above figure.
Cleal, oth pies ad ioe affet the size of a household’s oppotuit set. If a pie of a
set of prices falls but income stays the same, the opportunity set gets bigger and the household
is better off. We define real income as the set of opportunities to purchase real goods and
services. In this case, eal ioe ould’e goe up ee if the household’s ioe has ot.
On the other hand, when money income increases and prices go up even more, we say that the
household’s eal ioe has falle.
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The Equation of the Budget Constraint
The budget constraint equation for the above scenario would be 20X + 10Y = $200, with X
representing the number of Thai meals and Y representing the number of jazz club visits.
In general, the budget constraint can be written
PxX+ PyY = I,
with Px= price of X, X=quantity of X, Py=price of y, Y=quantity of Y, I=household income
Constraints Change When Prices Rise or Fall
Now suppose that Thai restaurants is offering two-for-one certificates good during the month
of November. In effect, this means that the price of Thai meals drops to $10 for Ann and Tom.
Basis of Choice: Utility
Utility: the satisfaction a product yields
Diminishing Marginal Utility
• Marginal utility (MU): the additional satisfaction gained by the consumption or use of
one or more unit of a good or service
• Total utility: the total amount of satisfaction obtained from consumption of a good or
service
• Marginal utility comes only from the last unit consumed, total utility comes from all
units consumed
• Law of diminishing marginal utility: the more of any one good consumed in a given
period, the less satisfaction (utility) generated by consuming each additional (marginal)
unit of the same good
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Allocating Income to Maximize Utility
Assuming that admission to both the country music club and the basketball games is free.
Frank would go to a basketball game for the first night because according to column 3 of the
table, the game gives him far more satisfaction (21 utils) than a trip to the club (12 utils).
Fo the seod ight, Fak a eithe go to the lu o the gae eause sie he’s ee to a
basketball game, the second game is worth only 12 utils while the first club visit is worth an
eual aout utils so he’s idiffeet aout where to go. “o he’ll split the et to ights:
one night he sees a basketball ball game number two (12 utils); the other night he spends at the
club (12 utils). At this point, Frank has been to two games and one club. He would go to the club
again because the marginal utility of a second trip to the club (10 utils) is greater than that of a
third game (9 utils).
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Document Summary
Income available to the household: price of the product, household"s a(cid:373)ou(cid:374)t of a(cid:272)(cid:272)u(cid:373)ulated (cid:449)ealth, price of other products available to the household, household"s tastes and preferences, household"s e(cid:454)pe(cid:272)tatio(cid:374)s a(cid:271)out futu(cid:396)e i(cid:374)(cid:272)o(cid:373)e, (cid:449)ealth, a(cid:374)d p(cid:396)i(cid:272)es. Budget constraint: limits imposed on household choice by income, wealth, and product prices. Choice set/opportunity set: the set of options that is defined and limited by a budget constraint. Suppose ann and tom are two struggling grad students whose tuition is paid by the graduate fellowships. The fellowships give them each month to cover all their other expenses. To si(cid:373)plif(cid:455) thi(cid:374)gs, let"s assu(cid:373)e that a(cid:374)(cid:374) a(cid:374)d tho(cid:373)as spe(cid:374)d their money on only two things: meals a local thai restaurant and nights out at a local jazz club. Their meals go for a fixed price of per couple, and two tickets to the jazz club are . The opportunity set is the shaded area in the above figure.
