Introduction to Agricultural and Natural Resources

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

2. 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

3. 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”.

4. Total and Marginal Utility

5. 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: people are rational, people can “rank” goods and services, and income (budgets) are limited.

6. 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.

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

8. Budget Constraint (Line)

9. 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”.

10. Consumer Equilibrium

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

12. 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”.

13. Deriving a Consumer’s Demand Curve

14. 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.

15. 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.

16. Market Demand Curve

17. 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.

18. Consumer Behavior and Demand

19. 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!

20. 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).

21. 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

22. 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

23. Effect of ED on Total Revenue • Why is price elasticity of goods and services important?

24. 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.

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

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

27. 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 (I1, Q1 and I2, Q2). • 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.

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

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

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

31. 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

32. Assignment 4 - Figure A

33. Assignment 4 – Figure B Note axis change!