qqq | Course Paper

3.1 Consumer Preferences

3.2 Budget Constraints

3.3 Consumer Choice

3.4 Revealed Preference

3.5 Marginal Utility and

Consumer Choice

3.6 Cost-of-Living Indexes

C H A P T E R 3

Prepared by:

Fernando Quijano, Illustrator

Consumer Behavior

CHAPTER OUTLINE

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Consumer Behavior

●theory of consumer behavior Description of how consumers

allocate incomes among different goods and services to maximize their well-

being.

Consumer behavior is best understood in three distinct steps:

1. Consumer Preferences

2. Budget Constraints

3. Consumer Choices

WHAT DO CONSUMERS DO?

Recent models of consumer behavior incorporate more realistic assumptions

about rationality and decision making.

A basic “workhorse” of economics, our model makes simplifying assumptions to

explain much of what we actually observe regarding consumer choice and the

characteristics of consumer demand.

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Consumer Preferences3.1

Market Baskets

●market basket (or bundle)List with specific quantities of one or more

goods.

TABLE 3.1 ALTERNATIVE MARKET BASKETS

A20 30

B10 50

D40 20

E30 40

G10 20

H10 40

MARKET BASKET UNITS OF FOOD UNITS OF CLOTHING

To explain the theory of consumer behavior, we will ask whether consumers

prefer one market basket to another.

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Some Basic Assumptions about Preferences

1. Completeness: Preferences are assumed to be complete. In

other words, consumers can compare and rank all possible

baskets. Thus, for any two market baskets A and B, a consumer

will prefer A to B, will prefer B to A, or will be indifferent between

the two. By indifferent we mean that a person will be equally

satisfied with either basket.

Note that these preferences ignore costs. A consumer might

prefer steak to hamburger but buy hamburger because it is

cheaper.

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2. Transitivity:

•Preferences are transitive.

•Transitivity means that if a consumer prefers basket A to basket B and

basket B to basket C, then the consumer also prefers A to C.

•Transitivity is normally regarded as necessary for consumer consistency.

3. More is better than less:

•Goods are assumed to be desirable—i.e., to be good.

•Consequently, consumers always prefer more of any good to less.

•In addition, consumers are never satisfied or satiated; more is always

better, even if just a little better.

Conclusion

•These 3 assumptions form the basis of consumer theory

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DESCRIBING INDIVIDUAL

PREFERENCES

•Because more of each

good is preferred to less,

we can compare market

baskets in the shaded

areas.

•Basket Ais clearly

preferred to basket G,

while Eis clearly preferred

to A.

•However, Acannot be

compared with B, D, or H

without additional

information.

FIGURE 3.1

Indifference Curves:

To show a consumer’s preferences graphically

●indifference curve Curve representing all combinations of market baskets

that provide a consumer with the same level of satisfaction.

•The indifference curve (U1)

that passes through

market basket A, shows all

baskets that give the

consumer the same level

AN INDIFFERENCE CURVE

FIGURE 3.2