Consumer BehaviorChapter OutlineConsumer BehaviorSlide 4Basic Properties of PreferencesSlide 6Slide 7Slide 8UtilityGenerating Equally Preferred BundlesIndifference CurvesIndifference Curve MapTransitivityConvexityTrade-offs Between GoodsMarginal Rate of SubstitutionDiminishing MRSPerfect Substitutes and Perfect ComplementsSlide 19Slide 20A C T I V E L E A R N I N G 1 Indifference CurvesBudget ConstraintsSlide 23Slide 24Slide 25The Best Feasible BundleSlide 27Marginal Utility and Consumer ChoiceCorner SolutionA C T I V E L E A R N I N G 2 Brenda wants to buy a new car and has a budget of $25,000.Consumer BehaviorChapter 3Chapter OutlinePreferencesBudget ConstraintsConsumer ChoiceConsumer Behaviortheory 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 3 steps:Consumer preferencesBudget constraintsConsumer choices● market basket (or bundle) List with specific quantities of one or more goods.Alternative Market BasketsA 20 30B 10 50D 40 20E 30 40G 10 20H 10 40Market Basket Units of Food Units of ClothingTo explain the theory of consumer behavior, we will ask whether consumers prefer one market basket to another.Consumer PreferencesBasic Properties of PreferencesThese properties characterize “rational” choiceCompletenessTransitivityCovexivityContinuityMore-Is-BetterBasic Properties of PreferencesCompletenessif A and B are any two situations, an individual can always specify exactly one of these possibilities:A is preferred to BB is preferred to AA and B are equally attractiveBasic Properties of PreferencesTransitivityif A is preferred to B, and B is preferred to C, then A is preferred to Cassumes that the individual’s choices are internally consistentConvexivitymixtures of goods are preferable to extremes.Continuityif A is preferred to B, then situations suitably “close to” A must also be preferred to BBasic Properties of PreferencesMore is better than less: Goods are assumed to be desirable—i.e., to be good. Consumers are never satisfied or satiated; more is always better, even if just a little better. Of course, some goods, such as air pollution, may be undesirable, and consumers will always prefer less. We ignore these “bads” in the context of our immediate discussion.UtilityGiven these assumptions, it is possible to show that people are able to rank in order all possible situations from least desirable to mostEconomists call this ranking utilityif A is preferred to B, then the utility assigned to A exceeds the utility assigned to BU(A) > U(B)Utility rankings are ordinal in naturethey record the relative desirability of commodity bundlesGenerating Equally Preferred BundlesIndifference CurvesAn indifference curve shows a set of consumption bundles among which the individual is indifferentQuantity of xQuantity of yx1y1y2x2U1Combinations (x1, y1) and (x2, y2)provide the same level of utilityIndifference Curve Mapa representative sample of the set of a consumer’s indifference curves, used as a graphical summary of her preference ordering.Quantity of xQuantity of yU1 < U2 < U3U1U2U3Increasing utility (we assume more is preferred to less)TransitivityIndifference curves cannot intersect.Quantity of xQuantity of yU1U2ABCThe individual is indifferent between A and C.The individual is indifferent between B and C.Transitivity suggests that the individualshould be indifferent between A and BBut B is preferred to Abecause B contains morex and y than AConvexityIf the indifference curve is convex, then the combination (x1 + x2)/2, (y1 + y2)/2 will be preferred to either (x1,y1) or (x2,y2)Quantity of xQuantity of yU1x2y1y2x1This implies that “well-balanced” bundles are preferred to bundles that are heavily weighted toward one commodity(x1 + x2)/2(y1 + y2)/2Trade-offs Between GoodsMarginal rate of substitution (MRS): the rate at which the consumer is willing to exchange the good measured along the vertical axis for the good measured along the horizontal axis.Equal to the absolute value of the slope of the indifference curve.Equal to the negative of the slope of the indifference curveMarginal Rate of SubstitutionQuantity of xQuantity of yx1y1y2x2U1dxdydxdyMRS Diminishing MRSPerfect Substitutes and Perfect Complementsperfect substitutes: Two goods for which the marginal rate of substitution of one for the other is a constant.perfect complements: Two goods for which the MRS is zero or infinite; the indifference curves are shaped as right angles.In (a), Bob views orange juice and apple juice as perfect substitutes: He is always indifferent between a glass of one and a glass of the other.In (b), Jane views left shoes and right shoes as perfect complements: An additional left shoe gives her no extra satisfaction unless she alsoobtains the matching right shoe.Perfect Substitutes and Perfect ComplementsPreferences for Automobile AttributesOwners of Ford Mustang coupes (a) are willing to give up considerable interior space for additional acceleration.The opposite is true for owners of Ford Explorers (b). They prefer interior space to acceleration.A C T I V E L E A R N I N G A C T I V E L E A R N I N G 11 Indifference CurvesIndifference CurvesA. Jane loves hamburgers and dislikes soft drinks. If she is served a soft drink, she will pour it down the drain rather than drink it. (Assume disposal is free.)B. Bob loves hamburgers and dislikes soft drinks. If he is served a soft drink, he will drink it to be polite.C. Mary always gets twice as much satisfaction from an extra hamburger as she does from an extra soft drink.Draw indifference curves that represent the following individuals’ preferences:Clothing (C)Budget ConstraintsThe table shows market baskets associated with the budget line F + 2C = $80Budget Constraints: Constraints that consumers face as a result of limited incomes.The Budget Line: All combinations of goods for which the total amount of money spent is equal to income.Market Baskets and the Budget LineA 0 40 $80B 20 30 $80D 40 20 $80E 60 10 $80G 80 0 $80Market BasketFood (F)Total SpendingF CP F P C I+ =income = $80price of food PF = $1 per unitprice of clothing PC = $2 per unit( / ) ( / )C F CC I P P P F= -Budget ConstraintsEffects of a Change in Income on the Budget LineEffects of