Question

Explain the consumer’s buying behavior in general based on a rigorous model. Your answer should include following concepts: budget constraint, preference ordering and its axioms, utility functions, marginal utility, marginal rate of substitution, utility maximizing choice, price-consumption curve, demand curve, incomeconsumption curve, Engel curve, substitution effect, income effect, normal goods, inferior goods, Giffen goods, upward sloping demand curve

In other words, you are required to recollect and summarize all scattered concepts you have learned, and make them into one line of story explaining an important economic phenomenon, i.e. consumer’s buying behavior. There is no fixed way of writing, but it is natural to start from budget constraint and preferenceutility, via mentioning utility maximizing point, and finally toward the derivation of demand curve and split it into three categories by the degree of substitution and income effect.

Answer 1

Budget constraint- Any consumer in order to maximise his level of satisfaction wants to purchase more and more of goods but he has to consider given budget constraints in terms of prices of goods and his income level.

Preference ordering/Strong Ordering/Revealed Preference- When a consumer chose any combination-A over other combinations then he relveals his preference for combination A than other combinations and this also shows his revealed preference.

Revealed Preference Axiom- if a consumer preferes combination A than other combination called B with his given budget constraint than it cannot be happen that he would choose/prefer combination B in other situation and this shows his preference should be consistent and same is called revealed preference axiom.

Cadinal utility funcion- According to it a person can measure/express his utility or satisfaction he drive from the goods in quantitative cardinal terms.

Ordinal utility funcion- According to it consumer is able to compare the different levels of satisfaction and able to jduge the stisfaction obtained from good or combination of goods is equal, lower or higher that another.

Marginal utility- it is the additional satisfaction/utility a consumer will get by consumer one more unit of a good or service.

Marginal Rate of substitution- The rate at which a consumer is ready to exchange good x and good y is called marginal rate of substitution, for example if consumer is ready to loose 3 units of Y for gaing one unit of X in order to have same level of satisfaction as before.

Utility maximisation/maximising satisfaction- A rational consumer will always try to maximise his satisfaction for a good or combination of goods.

Price Consumption Curve- Due to change in price by considering consumer's income, tastes and prices of other goods remains constant/remains the same then his demand for good will either increase or decrease depending upon fall or rise in price of the good in other words a consumer will be on higher indifference curve if there is a fall in price and will be on lower indifference curve if there is a rise/increase in price.

Income consumption curve- When a consumer increases or decreases the consumption of goods due to increase or decrease in his income and this shows the income effect on his demand for the two goods while prices of two goods, his taste and preferences remains the same as before or remains unchanged.

Engel Curve- The relationship between the levels of income and quantity purchased of particular commodities has been called the Engel curve and according to it when a consumers income got increased while prices of goods, consumers tastes and preferences remains unchanged then consumer will consumer/household's demand for necessities such as food will fall and his spent on luxuries will get increased.

Substitution effect- When a consumer's demand for good changes due to change in its relative price alone and while his real income or level of satisfaction remains constant.

Income effect- It shows change in quantity of goods purchased due to change in money income of consumer while the prices of goods and consumer's tastes and preferences remains constant/unchanged.

Normal goods- Normal goods are the goods for which demand increases when income gets increased and decreases when the income decreases and shows postive elasticity of demand.

Inferior goods- An inferior good is a good whose demand decreases as consumer's income increases and demand increases as consumer's income decreases.

Giffen goods- There are the goods for which demand increases as its prices increases and demand decreases as its prices decreases and strongy inferior goods are Giffen goods.

Upward sloping demand curve- It is applicable in case of Giffen goods and as in case of Giffen goods when price of giffen good rises then its demand also rises and when its price falls its demand also falls.