Microeconomics: Consumer Behavior and Decision Making

Modeling Consumers in Industrial Organization

• The learning objectives include reviewing microeconomic concepts, utility and demand, welfare analysis of market outcomes, and consumer surplus.
• The presentation focuses on the market for vegetables, with the consumer choosing quantities of different vegetables (tomatoes, cabbage, zucchini, etc.).

The Consumer Decision Problem

• The consumer problem is to choose quantities of several goods (e.g., vegetables) to maximize utility, given a budget constraint.
• The utility function is assumed to be quasi-linear, with a part depending on the goods and another part from the composite commodity (other goods).
• The budget constraint is represented by the equation P * Q + q0 = y, where P is the vector of prices, Q is the vector of quantities, q0 is the quantity of the composite commodity, and y is the total budget.

Maximizing Utility

• The consumer maximizes utility by choosing the optimal quantities of goods, given the budget constraint.
• The first-order conditions for maximization lead to the individual demand functions.
• There are two approaches to aggregating demand functions: the representative consumer approach and the heterogeneous consumers approach.

Representative Consumer Approach

• This approach assumes that all consumers can be summarized as one single consumer, representing the demand of the whole market.
• An example of a utility function is given, with two goods (tomatoes and cabbage).
• The inverse demand functions are derived, expressing prices as functions of quantities.
• The inverse demand functions are then inverted to obtain the demand functions, expressing quantities as functions of prices.

Inverse Demand Functions

• The inverse demand functions are given by P1 = a - B * q1 - D * q2 and P2 = a - B * q2 - D * q1.
• The parameters a, B, and D have economic interpretations:
  • a is the maximum price the consumer is willing to pay.
  • B is the rate at which the price decreases as the quantity increases.
  • D is a measure of substitutability between the two goods.

Demand Functions

• The demand functions are derived from the inverse demand functions.
• When D < B, the demand functions are linear, with a negative slope.
• When D = B, the goods are homogeneous, and the demand function is discontinuous.

Heterogeneous Consumers Approach

• This approach assumes that consumers are different, with different willingness to pay.
• An example is given, with 1,000 potential consumers, each with a unit demand (willing to buy one unit or zero).
• The willingness to pay is drawn from a uniform distribution between 0 and 1.
• The demand function is derived by aggregating the unit demands of all consumers.

Consumer Surplus

• The consumer surplus is defined as the net benefit from being able to purchase a good or service.
• It is computed as the difference between the willingness to pay and the price actually paid.
• The consumer surplus is used as a measure of the well-being of consumers in the market.
• An example is given, computing the consumer surplus in both examples.

Modeling Consumers in Industrial Organization

• Learning objectives include reviewing microeconomic concepts, utility, and demand, welfare analysis of market outcomes, and consumer surplus.

The Consumer Decision Problem

• Consumer problem involves choosing quantities of multiple goods to maximize utility within a budget constraint.
• Utility function is assumed to be quasi-linear, comprising a part dependent on goods and another part from the composite commodity (other goods).
• Budget constraint is represented by the equation P * Q + q0 = y, where P is the vector of prices, Q is the vector of quantities, q0 is the quantity of the composite commodity, and y is the total budget.

Maximizing Utility

• Consumer maximizes utility by choosing optimal quantities of goods given the budget constraint.
• First-order conditions for maximization lead to individual demand functions.
• Two approaches exist for aggregating demand functions: representative consumer approach and heterogeneous consumers approach.

Representative Consumer Approach

• Assumes all consumers can be represented by a single consumer, summarizing the demand of the whole market.
• Example utility function is provided, featuring two goods (tomatoes and cabbage).
• Inverse demand functions are derived, expressing prices as functions of quantities, and then inverted to obtain demand functions, expressing quantities as functions of prices.

Inverse Demand Functions

• Inverse demand functions are given by P1 = a - B * q1 - D * q2 and P2 = a - B * q2 - D * q1.
• Parameters a, B, and D have economic interpretations:
  • a is the maximum price the consumer is willing to pay.
  • B is the rate at which the price decreases as the quantity increases.
  • D is a measure of substitutability between the two goods.

Demand Functions

• Demand functions are derived from inverse demand functions.
• When D < B, demand functions are linear with a negative slope.
• When D = B, goods are homogeneous, and the demand function is discontinuous.

Heterogeneous Consumers Approach

• Assumes consumers are different, with varying willingness to pay.
• Example is given, featuring 1,000 potential consumers, each with a unit demand (willing to buy one unit or zero).
• Willingness to pay is drawn from a uniform distribution between 0 and 1.
• Demand function is derived by aggregating the unit demands of all consumers.

Consumer Surplus

• Consumer surplus is defined as the net benefit from being able to purchase a good or service.
• It is computed as the difference between the willingness to pay and the price actually paid.
• Consumer surplus is used as a measure of the well-being of consumers in the market.
• Example is given, computing the consumer surplus in both examples.