Consumer Behaviour

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CHAPTER

3
Consumer  Behavior

CHAPTER 3 OUTLINE

3.1 Consumer Preferences 3.2 Budget Constraints 3.3 Consumer Choice Chapter 3: Consumer Behavior

3.4 Revealed Preference 3.5 Marginal Utility and Consumer Choice 3.6 Cost-of-Living Indexes

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:

Chapter 3: Consumer Behavior

1. Consumer preferences 2. Budget constraints 3. Consumer choices

3.1

CONSUMER PREFERENCES

Market Baskets
●market

basket (or bundle) List with specific quantities of one or more goods. TABLE 3.1 Alternative Market Baskets
Market Basket Units of Food Units of Clothing

A
Chapter 3: Consumer Behavior

20 10 40 30 10 10

30 50 20 40 20 40

B D E G H

To explain the theory of consumer behavior, we will ask whether consumers prefer one market basket to another.

3.1

CONSUMER PREFERENCES

Some Basic Assumptions about Preferences

1.Completeness: Preferences are assumed to be complete. In other words, consumers can compare and rank all possible baskets. Chapter 3: Consumer Behavior

Note that these preferences ignore costs. A consumer might prefer steak to hamburger but buy hamburger because it is cheaper.

3.1

CONSUMER PREFERENCES

Some Basic Assumptions about Preferences

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. Chapter 3: Consumer Behavior

Transitivity is normally regarded as necessary for consumer consistency.

3.1

CONSUMER PREFERENCES

Some Basic Assumptions about Preferences

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. Chapter 3: Consumer Behavior

In addition, consumers are never satisfied or satiated; more is always better, even if just a little better. We ignore these “bads” in the context of our immediate discussion.

3.1

CONSUMER PREFERENCES

Indifference curves
Figure 3.1 Describing Individual Preferences

Chapter 3: Consumer Behavior

Basket A is clearly preferred to basket G, while E is clearly preferred to A. However, A cannot be compared with B, D, or H without additional information.

3.1

CONSUMER PREFERENCES

Indifference curves
●indifference

curve Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction. Figure 3.2 An Indifference Curve

Chapter 3: Consumer Behavior

3.1

CONSUMER PREFERENCES

Indifference Maps
● indifference

map Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent. Figure 3.3 An Indifference Map

Chapter 3: Consumer Behavior

3.1

CONSUMER PREFERENCES

Indifference Maps
Figure 3.4 Indifference Curves Cannot Intersect

Chapter 3: Consumer Behavior

If indifference curves U1 and U2 intersect, one of the assumptions of consumer theory is violated.

3.1

CONSUMER PREFERENCES

The Marginal Rate of Substitution
● marginal

rate of substitution

Maximum

amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good. Chapter 3: Consumer Behavior

The magnitude of the slope of an indifference curve measures the consumer’s marginal rate of substitution (MRS) between two goods.

3.1

CONSUMER PREFERENCES

The Marginal Rate of Substitution
Figure 3.5 The Marginal Rate of Substitution

Chapter 3: Consumer Behavior

Convexity The decline in the MRS reflects a diminishing marginal rate of substitution. When the MRS diminishes along an indifference curve, the curve is convex.

3.1

CONSUMER PREFERENCES

Perfect Substitutes and Perfect Complements
●perfect...
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