Chapter 5: Theory of Consumer Behavior
Chapter 5:
THEORY OF CONSUMER BEHAVIOR
Essential Concepts
1. The basic consumer optimization problem facing each individual can be stated as follows: Individual
2. Basic consumer theory assumes that buyers are completely informed about all things that matter to
3. Consumer theory requires that consumers be able to rank all consumption bundles according to the
level of satisfaction they would receive from consuming the various bundles.
4. Consumer preference ranking must satisfy two properties: preferences must be complete and
transitive. Preferences are complete when for every possible pair of consumption bundles, A and B,
5. While completeness and transitivity are absolutely necessary assumptions in consumer theory, it is
convenient to add a third assumption (nonsatiation): more of a good is always preferred to less of a
good.
7. Indifference curves provide a means of depicting graphically the preferences of a consumer. An
indifference curve is a set of points, representing different bundles of goods and services, each of
which yields the same level of total utility or satisfaction.
8. Indifference curves are negatively sloped and convex. Therefore, if the consumption of one good is
increased, consumption of the other must be reduced to maintain a constant level of utility. The
9. An indifference map consists of several indifference curves. The higher (or further to the right) an
indifference curve is on the map, the greater the level of utility associated with the curve.
10. Marginal utility is the addition to total utility that is attributable to the addition of one unit of a good
Chapter 5: Theory of Consumer Behavior
12. The consumer’s budget line shows all possible commodity bundles that can be purchased at given
prices with a fixed amount of money income. The relation between money income (M) and the
13. An increase (decrease) in income causes a parallel outward (backward) shift in the budget line. An
increase (decrease) in the price of X causes the budget line to pivot inward (outward) around the
original vertical intercept.
14. A consumer maximizes utility subject to a limited money income at the combination of goods for
which the indifference curve is just tangent to the budget line. At this combination, the marginal rate
of substitution (the absolute value of the slope of the indifference curve) is equal to the price ratio (the
15. The demand curve of an individual for a specific commodity relates utility-maximizing quantities
16. Market demand is a list of prices and the quantities consumers are willing and able to purchase at
17. Because demand prices along market demand measure the economic value of each unit of the good, a
market demand can be interpreted as the marginal benefit curve for a good.
Chapter 5: Theory of Consumer Behavior
Answers to Applied Problems
1. a. No, Bridget is not making the utility-maximizing choice. Currently, MUW /PW = 50/10 = 5 <
MUC / PC = 40/4 = 10; the last dollar spent on cheese yielded more satisfaction than the last
2. a. 3, 7, and 5 cups per day of Rice Krispies, cottage cheese, and popcorn, respectively.
b. 2, 6, 4
3. Any benefit package might be preferred by employees over higher wages due to the increased income
tax liability that arises from increased money income. A flexible package gives the employees a
4. Let π be profits, which depend on the level of output (Q), and K be the level of charitable
contributions. The utility function can be written as U = U[π(Q),K]. The firm’s total cost is the cost
5. a. MUNike / PNike > MUReebok / PReebok
b. MUBoxster / PBoxster < MUMiata / PMiata
6. a. No
b. No, he meant the ratio of marginal benefit (quality of the plane) to price of the plane was higher
Answers to Mathematical Exercises
1. a. L =X2Y2 + λ(M–PxX–PyY)
F.O.C.:
X
L
b. Using the first two FOCs:
x
y
YP
XP
=
so
x
y
P
YX
P
=
. Substituting this expression into the constraint:
0
x
xy
y
P
M P X P X
P
− − =
2. a. L = (X + 2)(Y + 1) + λ(95–10X–5Y)
F.O.C.:
X
L
= Y + 1 – λ10 = 0