Consumer Theory (Applications)Tutorial 5

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Applying Consumer Theory

Using consumer theory, we can examine the changes in the consumer choices whenever there is a change in an exogenous determinant.

Study how a consumer is affected by the adoption of different pricing schemes by firms, the imposition of different government policies, and a variety of other consumer choices such as labor-leisure choice, borrowing and lending.

Applying the consumer theory, we attempt to provide answers to two main questions:- Will the consumer be better off?- How will the consumer change his consumption choice?

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Comparative Statics Analysis: Changes in Income

Suppose Income increases from I1 to I2

U1

U2

E2

x

y

BL2

E1

BL1

1x

1y

MUST the consumer be better off?

• How many cases we have to consider?

How will the consumption choice change?

• Normal good? Inferior good?

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Comparative Statics Analysis: Changes in Price

Suppose price of good x decreases from to

U1

U2

E2

x

y

BL2

E1

BL1

1x

1y

MUST the consumer be better off?

• How many cases we have to consider?

How will the consumption choice change?

• Assumes Law of demand hold

1xp2xp

1/ xpI

2/ xpI

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Discussion Question 2

Should you have a buffet dinner or a regular dinner?- Some restaurants offer buffet dinner. A consumer pays $200 and can consume

all he wants.

U1

E1

Food (dish, f)

Other Good (y)

BL1

U2E2

BL2

I/Py

(I – 200)/Py

200/Pf I/Pf

Pf/Py= 0

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Discussion Question 2

Should you have a buffet dinner or a regular dinner?- Some restaurants offer buffet dinner. A consumer pays $200 and can consume

all he wants.

U1

E1

Food (dish, f)BL1

U2

E2 BL2

I/Py

(I – 200)/Py

200/PfI/Pf

Other Good (y)

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Discussion Question 1

Draw the indifference curve for good A and B if they are:

- Perfect Substitutes

- Perfect Complements

Discuss the consumer equilibrium in these cases.

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Perfect Substitutes

x (e.g., distilled water)

y (e.g., mineral water)

U1 U2U3

BL1

BL2

E

1y

x

PP

MRS

y

x

PP

MRS

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Perfect Complements

x (e.g., lens)

y (e.g., glasses frame)

U1

U2

U3BL1

BL2

E

1

2 4

2

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Discussion Question 3

Can you benefit from the Uncle Russ Coffee’s “Chops” program?- When a consumer buys a cup of coffee at Uncle Russ Coffee, he also receives

“a chop”. Uncle Russ Coffer offers a free drink for the consumers who have collected “12 chops” In other words, it is a “buy 12 get one free” program.

Coffee (c)12 13

U1

E1

Other Good (y)

BL1

U2

E2

BL2

I/Py

I/Pc

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Discussion Question 3

Can you benefit from the Uncle Russ Coffee’s “Chops” program?- When a consumer buys a cup of coffee at Uncle Russ Coffee, he also receives

“a chop”. Uncle Russ Coffer offers a free drink for the consumers who have collected “12 chops” In other words, it is a “buy 12 get one free” program.

Coffee (c)12 13

U1

E1

Other Good (y)

BL1BL2

I/Py

I/Pc

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Quantity Discount

Quantity Discount- One of the two supermarket giants, Wellcome, offered a 50% discount for the

second unit a consumer buys.

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Discussion Question 4

Sichuan Earthquake Relief: In-Cash Donation vs. In-Kind Donation

- After the Sichuan earthquake in May, 2008, huge amounts of donation were received from the public in Hong Kong. While many of us contributed in-cash donation, some people contributed in-kind or in-service donation.

- Some organizations recommended people to contribution in-cash donation rather than in-kind donation. Why?

- Let’s compare the difference between a donation of $1000 and a donation of $1000 worth food.

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Discussion Question 4

Food (f)

E1

(I+$1000)/Py

U2

E2 BL1

BL2

Y/Pf(Y + $1000)/Pf

U1

Other Good (y)

I/Py

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Discussion Question 4

Food (f)$1000/pf

E1

(I+$1000)/Py

U2

E2 BL1

BL2

I/Pf(I + $1000)/Pf

U1

Other Good (y)

I/Py

BL3

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Discussion Question 4

Food (f)

E1

E2

E3

Y/pf(i + $1000)/pf$1000/pf

(I+$1000)/Py

U2

U3

BL1

BL2

Y/Pf

Other Good (y)

I/Py

BL3

U1

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FB2400 - Essay Question

After cutting the Comprehensive Social Security Assistance (CSSA) cash allowance for the elderly (from HK$2,400 to HK$2,200) by the Social Welfare Department in early October 2005, the department is now considering to subsidize the cost of Chinese medicine consultations of elderly. It is proposed that the elderly could reimburse their cost of Chinese medicine consultations up to certain amount.

a. Suppose that the upper limit of the subsidy is HK$200, which is exactly equal to the full amount of the social security cut. Use the indifference curve and budget line to show and explain the effects of the proposed policy on the elderly.

b. While the pressure groups and legislators generally welcomed the proposal, they recommended the government to simplify the administrative procedures of the scheme, which makes it very hard to reimburse the full amount. Use the indifference curve and budget line to discuss the effects of the imposition of these requirements on the elderly. Do you support the imposition of these requirements?