Microeconomics II introductory lecture ØName of the lecturer: Petr Musil, office # 621 (6th floor – Department of Economics) ØOffice hours – Mondays 9.30 – 11.00 a.m. ØContact – pmusil@econ.muni.cz ØICQ: 248255928 ØCourse information: Study materials in IS – MPE_AMI2 Ø Ø Exam NWritten multiple-choice test – to pass you need at least 60 % score NTest structure: each question includes 4 possible answers (theory + applications), 0-4 right answers vs. only 1 of 4 right answers => not sure yet, but will let you know in time... NHow to succeed: get the theory – be able to apply the theory – not to underestimate the preparation – use your own brain Literature ØFrank, R.: Microeconomics and Behavior (whatever edition) n ØVarian, H.R.: Microeconomics: a Modern Approach (whatever edition) 1. Introduction to the consumer´s behaviour analysis What is the goal of the consumer´s behaviour theory? Øto understand and take the terms like: rationality, utility, sacrifice, thus... Ø...to understand principles of consumer´s choice out of several alternatives (i.e. in consumption) Øthe goal of the theory IS NOT to provide an ordinary consumer with a „decision making manual“ – an ordinary consumer is responsible and knows his or her preferences Rationality n Is the behavior of an ordinary consumer rational? How do we know? → RATIONALITY AXIOMS: n 1.Axiom of instauration – consumer prefers higher quantity of all goods to lower quantity (in the case of „eligible“ goods) 2.Axiom of transitivity – if cage A is preferred to cage B, and B to cage C, then cage A must be preferred to cage C 3.Axiom of variety (diversity, convexity) – consumer prefers an average consumption to extremes – i.e. consumption of food and beverages nCan we simply say that: if all the axioms are fulfilled, the consumer´s behavior is rational, and if axioms are not fulfilled, the consumer´s behavior is irrational? nNO! The axiom fulfillness only gives chances that the observed behavior is rational nConsumer´s behavior might be rational in spite of axioms are not fulfilled, i.e.: Øineligible or neutral goods (insaturation axiom not valid) Øconsumer´s specialization (variety axiom not valid) Øsaturated preferences (insaturation axiom not valid) Rationality Rationality: summarry Ørational behavior leads to maximizing the consumer´s total utility Ørationality is a subjective category: we cannot say that this or that behavior is rational and this or that irrational Øin general – consumers behave themselves rationally, because they do their best decisions under given conditions (given information, disposable income, prices of goods and services etc.) Utility nUtility = an effect resulting from the consumption of specific combination of goods and (or) services - „variable“ showing the trend of consumer´s preferences n nUtility is not an objective category but a subjective one nHow can we (can we?) measure the utility? n n n n cardinalistic vs. ordinalistic n approach Cardinalism n CARDINALISTIC APPROACH – utility is measureable directly, it assumes specific value n n Menger, Jevons, Walras – cardinalists, but without explanation how to measure utility n n Alfred Marshall – utility measureable indirectly with the value of money – demand price n n Total Utility (TU) – total rate of needs satisfaction n Marginal Utility (MU) – change of TU induced with the consumption of additional unit of goods or services Ordinalism n ORDINALISTIC APPROACH – utility unmeasureable (or does not make any sence to measure it), but consumer is able to consider commodity cages from the utility point of view n n V. Pareto, J. R. Hicks - ordinalists n n Indifference Curve, (IC) – the set of combinations of several kinds of goods that give the consumer an equal level of total utility – an instrument to draw the consumer´s preferences Total utility - cardinalism TU=f(X,Y) Y X Total utility as a function of volume of goods X and Y Total utility - ordinalism TU1 TU2 TU3 Y X TU3 > TU2 > TU1 Further approaches to the utility theory n EXPRESSED PREFERENCES – refuses IC n i.e. Murray N. Rothbard: „consumer expresses his/her preferences at the moment of the decision (while shopping)“ n n the donkey and 2 haycocks theorem – a donkey cannot pick one of the 2 equal haycocks... so it dies from hunger n What are the Eeyore´s preferences? 14870766 ??? Vlákna Vlákna 15 metres 15 metres similar to IC - both haycocks are the same quality (equal total utility), so which one will Eeyore chose? Indifference curves characteristic 1.IC have a negative slope – in case of eligible goods, results from the insaturation axiom 2.IC do not cross each other – results from the transitivity axiom 3.There is an IC in each spot of consumption situation 4.IC are convex to the axes origin – results form the variety axiom – there are some exceptions (special shapes of IC) Marginal rate of substitution in consumption (MRSC) Ø= a ratio describing the consumer´s WILLINGNESS to substitute goods with each other with constant level of total utility Ø= a slope (tangent)of indifference curve... Ø... which generally changes alongside the IC ØMRSC = -ΔY/ΔX = MUX/MUY (for explicit changes) ... Ø ...=(δTU/δX)/(δTU/δY) (for dimensionless changes) MRSC – Cobb-Douglas preferences gummy bears chocolate 6 3 2 1 1 2 3,5 5 A B C D MRSC from A to B = – (6 – 3)/(2 – 1) = – 3, consumer is willing to give up 3 units of gummy bears to obtain 1 unit of chocolate: the ratio of substitution equals to 3:1 MRSC from C to D = – (2 – 1)/(5 – 3,5) = – 2/3, consumer is willing to give up 1 unit of gummy bears to obtain 1,5 units of chocolate: the ratio of substitution equals to 2:3 absolute value of MRSC decreases because of the decrease of number of gummy bears (they become more precious), so the consumer is willing to give up less units of gummy bears to obtain additional unit of chocolate MRSC – Linear preferences milk chocolate In this case the value of MRSC is constant, because the consumer is always willing to substitute the same volume of chocolates with each other – both kinds of chocolates are „perfect substitutes“ with ratio 1:2, MRSC = – 1/2 white chocolate Special shapes of IC X - coffee X – Pilsner Urquell Y - beer Y – soda water Coffe is ineligible goods – you have to buy coffee if you want to buy soda water Pilsner Urquell is a neutral goods – „I drink beer but I don´t care about Pilsner Urquell“ Special shapes of IC Y Y X X X changes from eligible to ineligible goods – „after the 10th beer I have a stomach ache“ Specializtion in consumption – it is possible to consume only one of the two goods – „I´ll spent my vacation either on Crete or Canary Islands“ Special shapes of IC Y Y X X X and Y are close substitutes, i.e.: croissants-bread, vanilla ice-chocolate ice X and Y are regular complements, i.e.: car-gassoline, bread-butter Y Y X ane Y are perfect substitutes, i.e.: Coca-cola - Pepsi, Nescafé-Tchibo etc. X and Y are perfect complements – objective: skis-ski bindings, subjective: „I drink each cup of coffe with two sugars“ X X Special shapes of IC Y Saturated preferences – consumer endeavours the speciffic combination of two goods (commodity cage) X Y X Discrete goods – obtainable only in solid units (i.e. you cannot buy only a half of cinema ticket) Special shapes of IC Consumer´s limits (possibilities) ØIC represent the consumer´s WILLINGNESS to a specific action (shopping, consumption etc.) Øgoods and services are usually not free Øthe consumer has to undergo a sacrifice to get the utility Øthe consumer´s possibilities are limited Øconsumer is limited with his/her:: disposable income (I) and prices of goods and services (P) → budget constraint Budget constraint nEquation of budget constraint (budget line – BL): nI = PX . X + PY . Y nor: nRESOURCES = USE OF RESOURCES nconsumer spends his/her entire disposable income, or, if he/she saves, the savings are one of the „bought“ goods X Y BL Budget Line Øfrontier that defines the „commodity space“ (lies on + under the budget line) Øset of accessible combinations of goods and services Øwe are interested in its: distance from the origin, slope, shape Distance from the origin of axes Øif disposable income rises, BL moves rightwards, if dicreases, BL moves leftwards X Y BL BL' BL'' I rises I decreases The slope of BL ØMarginal Rate of Substitution in Exchange (MRSE) Ø= ratio describing the possibility to change goods with each other on the market – tells us what are the relative prices of goods ØMRSE = - ΔX/ΔY = PX/PY X BL BL' BL'' PX/PY = 1/1 PX/PY = 1/2 Y PX/PY = 2/1 The shape of BL nTells us if the relative prices of goods change with the change of bought volume X Y BL X Y BL each additional dimensionless unit of goods is more expensive each additional dimensionless unit of goods is cheaper The shape of BL X Y BL X Y BL additional cumulated quantity of goods is more expensive additional cumulated quantity of goods is cheaper n... Is also affected with: Øtaxation (consumption and income taxes) Øsocial system Øother regulation (price reg., allowance system, etc.) Budget constraint Consumer´s equilibrium nConsumer is in equilibirium if he/she maximizes his/her total utility according to his/her preferences and possibilities (disposable income and goods prices) n Consumer´s equilibrium – case of sole goods or service nFor equilibrium stands: MUX = PX X PX MUX PX* E X* if bought volume less than X*, then additional units cause relatively higher growth of total utility in comparison to the growth of total expenditures (MU>P) – motivation to buy additional units of X if bought volume more than X*, then additional units cause relatively higher growth of total expenditures in comparison to the growth of total utility (MU MRSC - BL steeper than IC BL Consumer´s equilibrium – corner equilibrium Consumer´s surplus Øa difference between the total utility acquired from the consumption and the total expenditures spent to acquire the equilibrium volume of goods and services, or... Ø...a difference between the willingnes to spent and the necessity to spent some part of the disposable income ØCS (Consumer´s Surplus) = TU – PX . X Consumer´s surplus X PX MUX =PX =D 10 9 8 3 Bought quantity 1 2 3 MU 10 9 8 TU 10 19 27 Total expenditures 10 18 24 Consumer´s surplus of equilibrium quantity of X: CS = TU – PX . X = 27 – 24 = 3