31-MAR-2009 08:17 From:MED E MASS

021 532 0596

To:Natasha Hanslo

CONSUMER BEHAVIOUR: INDIFFERENCE APPROACH

• CONSUMER BEHAVIOUR IS VERY IMPORTANT BECAUSE 60% OF ALL GOODS AND SERVICES ARE PURCHASES BY CONSUMERS.

• DEMAND - DEMANDED

HIGHER PRICE LESS QUANTITY

LOWER PRICE GREATER QUANTITY DEMANDED

• LAW OF DEMAND: INVERSE RELATIONSHIP BETWEEN PRICE AND

QUANTITY

• 2 APPROACHES TO EXPLAIN DEMAND:

1. MARGINAL UTILITY APPROACH

2. INDIFFERENCE APPROACH

• INDIFFERENCE APPROACH DOES NOT NEED MEASUREMENT OF MARGINAL UTILITY

• THE INDIFFERENCE APPROACH - ORIGINATED VILFREDO PARETO (1848 -1923), AND ITALIAN ECONOMIST.

• SIR JOHN HICKS, BRITISH ECONOMIST DEVELOPED INDIFFERENCE APPROACH FURTHER.

• ADVANTAGES OF INDIFFERENCE APPROACH:

*UNLIKE UTILITY THAT CANNOT BE MEASURED.

* ALLOWS A DISTINCTION TO BE MADE THE INCOME EFFECT AND SUBSTITUTION EFFECT.

1: A USEFUL TOOL TO ANALYSE CONSUMER CHOICE.

31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

CARDINAL AND ORDINAL UTILITY

; II

);;> CARDINAL UTILITY IS THE BASIS FOR THE UTILITY APPROACH

• ORDINAL UTILITY IS THE BASIS FOR THE INDIFFERENCE APPROACH

• DIFFERENCE BETWEEN CARDINAL AND ORDINAL APPROACH

• EXAMPLE OF CARDINAL APPROACH:

TOWN A IS 75KM FROM CAPE TOWN TOWN B IS 300 KM FROM CAPE TOWN

THUS TOWN B IS FOUR TIMES FURTHI;:R AWAY FROM CAPE TOWN

DISTANCES CAN ACTUALLY BE MEASURED

• EXAMPLE OF ORDINAL APPROACH:

SIMPLY INDICATES SOME DISTANCES ARE SHORTER THAN, LONGER THAN

• CARDINAL UTILITY ASSUMES THAT SATISFACTION (=BENEFIT = UTILITY) CAN BE MEASURED ON A CARDINAL SCALE

• ORDINAL UTILITY ASSUMES THAT SATISFACTION OF CONSUMERS CAN BE RANKED OR ORDEREb

• THE SIZE OF THE UTILITY DIFFERENCES CANNOT BE ESTABLISHED BUT THE CONSUMER CAN ONLY RANK GOODS FROM HIGHEST TO LOWEST OR BEST TO WORST

• THE INDIFFERENCE APPROACH IS BASED ON THE NOTION OF UTILITY

• INDIFFERENCE APPROACH ALLOWS COMPARISON OF DIFFERENT COMBINATIONS OF GOODS.

31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

P.Y9

!3

II

II

3 BASIC ASSUMPTIONS

1. COMPLETENESS - ASSUMES THAT CONSUMERS ARE ABLE TO RANK ALL POSSIBLE COMBINATIONS OF GOODS IN ORDER OF PREFERENCE.

• EXAMPLE: 2 BUNDLES OF GOODS

\

* BUNDLE X : 2 PORTIONS OF MEAT AND 5 LlTRES OF MILK

* BUNDLE Y : 1 PORTION OF MEAT AND 8 LlTRES OF MILK

'" A CONSUMER MUST BE ABLE TO RANK PREFERENCE : EITHER X OR Y

2. CONSISTENCY: CONSUMERS ARE ASSUMED TO ACT CONSISTENTL Y

• EXAMPLE: 3 BUNDLES OF GOODS A,B,C

• IF A CONSUMER PREFERS A TO BAND B TO C LOGICALLY THE CONSUMER MUST PREFER A TO C

3. NON - SATIATION: CONSUMERS ARE NEVER FULLY SATISFIED AND ALWAYS PREFER MORE OR LESS.

• EXAMPLE: IF BUNDLE A CONSISTS OF 2 KG OF MEAT AND 2 DOZ. BEERS WHILE BUNDLE B CONSISTS OF 2KG OF MEAT AND 3 DOZ. BEERS

• THE CONSUMER ASSUMED TO FAVOUR BUNDLE B OVER A.

31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

INDIFFERENCE CURVES

• AN INDIFFERENCE CURVE IS A CURVE WHICH SHOWS ALL THE COMBINATIONS OF TWO PRODUCTS THAT WILL PROVIDE A CONSUMER WITH EQUAL LEVELS OF SATISFACTION

• AN INDIFFERENCE CURVE IS DRAWN BY JOINING THE POINTS OF SATISFACTION REPRESENTING DIFFERENT COMBINATIONS OF TWO GOODS WHICH ARE EQUALLY

DESIRABLE. I

• NOTE:

*THE CURVE BULGES TOWARDS THE ORIGIN

*THE CURVE 15 CONVEX TO THE ORIGIN

* MOVEMENT DOWNWARDS TO THE RIGHT SHOWS THE CURVE BECOMING FLATTER -ITS SLOPE DECREASES

*THE GRAPH SHOWS AS MORE MEAT IS PREFERRED LESS VEGETABLES ARE PREFERRED

• THE LAW OF SUBSTITUTION STATES THE MORE SCARCE A GOOD BECOMES, THE GREATER ITS SUBSTITUTION VALUE.

• EXAMPLE: POINTS A AND B

*3 PORTIONS OF VEGE$ FOR 1 PORTION MEAT *POINTS C AND D

*1,1;2 PORTION OF VEGES FOR 1 PORTION OF MEAT

• THE MARGINAL RATE OF SUBSTITUTION: THE RATE AT WHICH A CONSUMER IS PREPARED TO SACRIFICE A SMALL QUANTITY OF ONE GOOD TO GAIN MORE OF

ANOTHER GOOD I

• THE LAW OF SUBSTITUTION CAN ALSO BE KNOWN AS THE LAW OF DIMINISHING MARGINAL RATE OF SUBSTITUTION

31-MAR-2009 08:17 From:MED E MASS

021 532 0596

To:Natasha Hanslo

I PROP-;RTIES OF INDIFFERENCE CURVES ~

• INDIFFERENCE CURVES USUALLY SLOPE DOWNWARDS TO THE RIGHT

• AN INDIFFERENCE CURVE SHOWS THE VARIOUS COMBINATIONS OF 2 GOODS WHICH YIELD THE SAME LEVEL OF SATISFACTION FOR A CONSUMER

• IT IS POSSIBLE TO DRAW A SERIES OF INDIFFERENCE CURVES FOR A CONSUMER'S CHOICE BETWEEN TWO GOODS

• A COLLECTION OF INDIFFERENCE CURVES IS KNOWN AS AN INDIFFERENCE MP.

• INDIFFERENCE CURVES NEVER INTERSECT OR TOUCH EACH OTHER

THE BUDGET LINE

• CONSUMER SATISFACTION DEPENDS ON (ISA FUNCTIONS OF) INCOME

• WHAT COMBINATIONS OF GOODS SATISFIES A CONSUMER DEPENDS ON WHAT THE CONSUMER CAN AFFORD

• IF A CONSUMER HAS R12 AVAILABLE TO SPEND ON VEGETABLES AND MEAT

• IF THE PRICE OF MEAT = R3 PER PORTION

• IF THE PRICE OF VEGETABLES = R2 PER PORTION

R12 WILL BUY:

1. 6 PORTIONS OF VEGES. BUT NO MEAT

2. 4 PORTIONS OF MEAT BUT NO VEGES

3. VARIOUS COMBINATIONS OF MEAT AND VEGES

I

• A BUDGET LINE CAN BE DERIVED BY USING THE TWO EXTREMES AND THE VARIOUS COMBINATIONS

31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

CONSUMER EQUILIBRIUM

• IF THE BUDGET LINE IS SUPERIMPOSED ON AN INDIFFERENCE MAP THE BEST COMBINATION CONSIDERING THE CONSUMERJS AVAILABLE INCOME.

• CONSUMER EQUILIBRIUM OCCURS WHERE THE CONSUMER GETS THE BEST COMBINATION OF THE TWO GOODS WITH HIS AVAILABLE INCOME

• CONSUMER EQUILIBRIUM OCCURS WHERE THE BUDGET LINE IS TANGENTIAL TO (JUST TOUCHES) THE INDIFFERENCE CURVE.

• ANY POINT ABOVE TO THE RIGHT IS NOT AFFORDABLE

• ANY POINT BELOW AND TO TE LEFT IS A POINT THAT MEANS UNDER-UTILISATION OF THE RESOURCES.

AN ALGEBRAIC APPROACH

• I = INCOME AVAILABLE

• 2 GOODS: GOOD X AND GOOD Y

• LET Qx ;;; QUANTITY OF GOOD x Px = PRICE OF GOOD x

• LET c, = QUANTITY OF GOOD Y

Py = PRICE OF GOOD y

THUS INCOME = (PRICE OF Y MULTIPLIED BY QUANTITY OF y

PLUS

PRICE OF x MULTIPLIED BY QUANTITY OF x

OR

• I =: (Py Qy) + (Px Qx)

31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

Affordable combinations of vegetables and meat:

Combination Meat Vegetables
(portions per week) (portions per week)
I
I
I
0 I
a 6
b 1 41/2
C 2 3
d 3 11/2
e 4 0 31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

Two further sets of combinations of meat and vegetables between which a consumer is indifferent:

u. U3
Meat Vegetables Meat Vegetables
(portions per week) (portions per week) (portions per week) (portions per week)
l/z 6 JI/2 6
1 4 2 4V2
2 2 3 3
3 1 4% 2lJ2 31-MRR-2009 08:17 From:MED E MRSS

021 532 0595

To:Natasha Hanslo

Combinations of meat and vegetables that yield the same level of satisfaction

i I

Combination ! Meat Vegetables

! (portions per week) (portions per week)

4

2

A

1

6

B

2

3

c

3

D

i