CONSUMER AND PRODUCER THEORY
Lecturers: Marcel Kohler & Devi Tewari Rooms: Westville, J-Block, Room 367 & 362
This course aims to develop students’ understanding and ability to explain real-world economic phenomena with the help of microeconomic principles. In this first module, we try to establish what drives the behaviour of consumers and producers in an economy by focussing on explanations of how they attempt to maximise their well-being, subject to certain constraints.
Your prescribed text is as follows: J M. Perloff, Microeconomics, 6th Edition, Addison Wesley Longman, Boston, 2011. [abbreviated to Perloff in the module outline] Appendices, which cover additional references and applications of the theory included in the module, are taken from the supplementary materials accompanying the Perloff text. Note that these references and applications are an essential component of the course and are included in this module guide. Refer to the end of the session outline for these appendices. Microeconomics One Econ 202: 2012 Page: 1
CONSUMER CHOICE Preferences, Utilities and Budget Constraints Perloff, chapter: 4. (See: student resource kit, solved problem no.1)
According to economists, consumers maximise their utility (well-being) subject to constraints based on their income and the prices of goods. To predict consumers’ responses to changes in these constraints, economists use a theory about individuals’ preferences, which assumes that consumers are rational maximisers. The introductory sessions explore the characteristics of rational maximising consumers and develop a set of tools to analyse their decision-making process. Applications: Refer to Handbook Appendices for more detail. “Payments in kind” versus cash grants
Key concepts: properties of consumer choice: completeness, transitivity & insatiability (“more is better”). indifference curves & maps: 1. slope: marginal rate of substitution (willingness to substitute between goods). 2. curvature of indifference curves: perfect substitutes & perfect complements. utility: ordinal versus cardinal. the utility function & diminishing marginal utility. budget line/constraint: 1. slope: marginal rate of transformation 2. changes in prices versus income changes constrained consumer choice: consumer equilibrium interior versus corner solutions concave versus convex indifference curves
Concept Review: Indifference curve: combinations (bundles) of goods that give the same level of satisfaction. Budget constraint: all the possible combinations of goods that can be purchased. Consumer's constrained choice: picking the affordable bundle that maximizes utility. If V = good on the vertical axis and H = good on the horizontal axis, then: Indifference curve's slope = marginal rate of substitution = (V/H) = -MUH/MUV Slope of budget constraint = marginal rate of transformation = -pH/pV Interior solution: MUH/MUV = pH/pV or MUH/pH = MUV/pV
Econ 202: 2012 Page: 2
APPLYING CONSUMER THEORY Deriving Demand Curves and Income & Substitution Effects
Perloff, chapter: 5. (See: student resource kit, concepts review: consumer theory & solved problem no.10)
In these sessions, we use our most fundamental principle, rational maximisation, to show why supply and demand curves have their characteristic shapes. We derive individual demand curves by using the information about tastes contained in a consumer’s indifference curve map. We then examine the effects of a price change on quantity demanded. We establish that when a price changes, the total change in the quantity demanded is the sum of two effects: the substitution effect and the income effect. Lastly, we use consumer theory to derive the daily demand curve for leisure, which is time spent on activities other than work. By...