Our task in this essay is to understand the concept of
rational consumer choice, we will aid our knowledge by using a real-life offer.
A rational consumer is “A
person who weighs up the costs and benefits to him or her of each unit if a
good purchased.” (Sloman, Wride and Garratt, 2015)
Our consumer is a student with an income of £50 to spend on rice (Good
X), costs £2 each, and beef, costs £5 each (good Y). If all the £50 was spent
on rice than 25 items could be bought. If all the £50 was spent on beef then
only 10 items could be bought, this is exhausting all of the consumer’s income,
this is illustrated in the budget line. In turn, we also could look at the line
to see what other combinations we could have, for example, if the consumer only
bought 15 items of rice than 4 items of beef could be afforded. To buy some rice and beef means that 2.5x have
to be given up to be able to afford 1y., this is known as trade-off. This is shown diagrammatically in Figure 1.
Figure 1.1 also shows what can be afforded and what cannot be afforded given
the income of the consumer. The green
shaded area shows what cannot be affordable, this is because of anything above
the budget line, costs more than the income of the consumer. The red shaded
area shows what can be afforded, this is because it falls below the budget line
and doesn’t cost more than the available income.
Now that we know the budget of the consumer (£50), and what
can be afforded shown by figure 1 and figure 1.1. We will now add the concept
that to maximise the consumer’s satisfaction, the combinations of goods that
should be bough should be on the highest indifference curve. We will put these
ideas on the same graph which is shown in Figure 1.2. In this case, the indifference
map has been reduced to a few indifference curves and the budget line has been
drawn. “An indifference curve depicts the points of equally desirable
and Nordhaus, 1992)
Figure 1.2 the budget line touches two different indifference
curves. I1 touches at points A and C. I2 at point B. The bundles of rice and
beef at points can all be afforded at points A, B, and C, therefore we need to
see which combination gives the most satisfaction. I2 is at a higher point than
I1, therefore representing a higher level of satisfaction than any bundle on I1.
When the budget line touches the indifference curve, depicted
in figure 1.2 by point B this is called a tangent. The consumer is said to be
in equilibrium, therefore meaning that they obtain the highest level of
satisfaction that the budget allows at that point, when the budget line is
tangent to the indifference curve.
A change in income creates a change in the budget line. Also,
a change in the price of the goods can increase or decrease the number of goods
that a consumer will be able to purchase.
In this case, the price of rice has reduced. Due to black Friday
Tesco has implemented a 50% reduction in rice products. This change on the
budget line is shown graphically in figure 1.3.
Figure 1.3 the original budget line is A, the new budget
line is B with the new price reduction. If the price of good x (beef) falls in
price and the price of good Y (rice) stays the price, then more rice can buy
for the same amount of money (50 items of rice). This gives a different slope
to the budget line and will probably mean that it will touch a new indifference
curve. Giving higher levels of satisfaction.
In figure 1.4 the initial budget line is A and the consumer
is in equilibrium at E3 this is where the budget line is tangential to the
indifference curve. After the occurrence of a fall in the price of rice the
budget line has pivoted to B, this allows the consumer to move onto a higher indifference
curve (I2) thus resulting in a new equilibrium E4. The line that has joined the
points E3 and E4 of the consumer equilibrium is the price-consumption line.
Price consumption line “A line showing how a person’s optimum level of
consumption of two goods changes as the price of one of the two goods change”(Sloman, Wride and Garratt, 2015)
How does a consumer’s choice change if the price of one good
changes? As the price of product rice has reduced it becomes cheaper in
comparison to beef and for this reason the consumer will substitute beef for rice.
This occurrence is called the substitution effect of a price change. It is
rational that the consumer will substitute towards the product which has become
cheaper. As the price of rice is reduced it also means that the consumer has
more money to spend on the other good. Thus presumed that the consumer’s real
income has increased since it costs less to buy a given quantity of goods. This
may mean that the consumer buys more rice, this is known as the income effect
of a price change.
What happens if the consumer has different preferences? Here the consumer only cares about the
total number of X + Y that they have, not whether they are getting more of X or
Y, so the indifference curves are straight lines is known as perfect
substitutes, figure 1.5. If a customer can’t consume a good without the other
this is known as perfect complements, figure 1.6.
The economic model can explain how a person chooses between
rice and beef. However, you might have some skepticism. As a consumer, you don’t
decide what to buy by writing a budget constraint and indifference curves. The model
does have merits, consumers are aware of constraints when it comes to financial
resources. (Mankiw and Taylor, n.d.)
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Samuelson, P. and Nordhaus, W.
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Sloman, J., Wride, A. and Garratt, D.
Sloman, J., Wride, A. and Garratt, D.
(2015). Economics. 9th ed. Harlow, England: Pearson, pp.101, 116.
Mankiw, N. G. and Taylor, M. P.
Mankiw, N. and Taylor, M. (n.d.). Economics.
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Ison, S. and Wall, S. (2007). Economics.
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