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Berkeley ECON 100A - Consumer Choice

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1Chapter 4Consumer ChoiceKey issues1. properties of preferences2. utility3. budget constraint4. consumer's constrained choiceTastes• individual tastes (preferences) determine pleasure people derive from goods• economists usually • take tastes as given• do not judge tasteIndividual decision making• consumers face constraints on their choices• consumers maximize their pleasure from consumption subject to constraints • we want to predict behavior--not judge iConsumer’s problem• consumer allocates money over goods: buys a bundle or market basket of goods• 2 possible theories of consumer behavior• maximizing behavior• random behavior (next chapter)Assumptions about consumer preferences1. completeness2. transitivity3. more is better2Assumption 1: Completeness• consumer can rank any two bundles of goods• only one of following is true: consumer • prefers Bundle x to Bundle y• prefers Bundle y to Bundle x• is indifferent between themAssumption 2: Transitivity (rationality)• consumer's preference over bundles is consistent:• if consumer prefers• Bundle z to Bundle y and• Bundle y to Bundle x• then consumer prefers Bundle z to Bundle xEconomist’s transitivity experiment • Weinstein (1968)• no subject knew the purpose of the experiment• each given choices between 10 goods of equal value, offered in all possible combinations of pairs• $3 in cash• 8-cup Wearever aluminum coffee percolator• free pass to next 4 Saturday matinees at subject's favorite motion picture theaterResults• transitive responses• 93.5% adults (≥ 18 years old) • 79.2% children aged 9 to 12• result may explain why political and economic restrictions are placed on youthsPsychologists' transitivity experiment• Bradbury and Ross (1990)• share of people who made intransitive choice involving 3 colors:• nearly 50% of 4 or 5 year olds • 15% of 11-13 year olds• 5% for adults• novelty (a preference for a new color) is responsible for most of the intransitive responses• novelty effect is especially strong in childrenAssumption 3: More is better• more of a good is better than less of it• good: commodity for which more is preferred to less at least at some levels of consumption• bad: something for which less is preferred to more, such as pollution• consumers are not satiated3Which assumptions are critical for our model?• completeness and transitivity assumptions are crucial• more-is-better assumption is included only to simplify the analysisWhy do economists make the more-is-better assumption? • it appears to be true about most people• with free disposal, you can't be worse off with extra goods• consumers only buy goods where this condition is met (we'll show later)Preference maps• we summarize information about a Lisa’s preferences using a graph• we can rank some bundles using more-is-better assumptionFigure 4.1a Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(a) Ranking Regions302515Z, Pizzas per semester252015100dabecfABIndifference curve• we ask Lisa to identify all the bundles that give her the same amount of pleasure as consuming bundle e• her answer: Curve I in Figure 4.1b, “Indifference Curve”Figure 4.1b Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(b) Indifference Curve302515Z, Pizzas per semester252015100dabIecf4Indifference or preference map• complete set of indifference curves that summarize a consumer's tastes• Figure 4.1c shows parallel curves, but they need not be parallelFigure 4.1c Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(c) Preference Map302515Z, Pizzas per semester252015100dI0I1I2ecfIndifference curve properties1. bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin2. there is an indifference curve through every possible bundle3. indifference curves cannot cross4. indifference curves are “thin”5. indifference curves slope downProperty 1: Better off on farther indifference curves• bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin• by more is better assumptionFigure 4.1c Bundles of Pizzas and Burritos Lisa Might ConsumeB, Burritosper semester(c) Preference Map302515Z, Pizzas per semester252015100dI0I1I2ecfProperty 2: Indifference curve through every possible bundle • by completeness: consumer can compare any bundle to another • compared to a given bundle, some bundles are• preferred, • enjoyed equally•inferior • connecting bundles that give the same pleasure produces an indifference curve that includes the given bundle5Property 3: Indifference curves cannot cross• assume the opposite: two indifference curves cross at Bundle e in Figure 4.2a.• look for a contradictionFigure 4.2a Impossible Indifference CurvesB, Burritosper semester(a) CrossingZ, Pizzas per semesterI1I0abeProperty 4: Indifference curves are "thin"• assume the opposite: suppose an indifference curve were thick (Figure 4.2c).• look for a contradictionFigure 4.2c Impossible Indifference CurvesB, Burritosper semesterab(c) ThickZ, Pizzas per semesterIProperty 5: Indifference curves slope down• assume the opposite: indifference curve Islopes up in Figure 4.2b• look for a contradictionFigure 4.2b Impossible Indifference CurvesB, Burritosper semester(b) Upward SlopingZ, Pizzas per semesterIab6Willingness to substitute• downward-sloping indifference curve ⇒consumer is willing to substitute one good for the other• marginal rate of substitution (MRS) of burritos (rise) for pizza (run), is slope of indifference curve:BMRSZ∆=∆MRS varies along the indifference curve• indifference curve bow away from the origin (convex)• indicates diminish marginal rates of substitution (MRS) Figure 4.3a Marginal Rate of SubstitutionB, Burritosper semester(a) Indifference Curve Convex to the Origin5381–11120–2–33456Z, Pizzas per semesterabcdIConcave indifference curve• if indifference curve bows toward the origin (concave) • then (implausibly) increasing MRSFigure 4.3b Marginal Rate of SubstitutionB, Burritosper semester(b) Indifference Curve Concave to the Origin571120–2–33456Z, Pizzas per semester abcIPerfect substitutes• straight line indifference curves• if slope is –1, MRS = 1 (Coke-Pepsi)7Figure 4.4a Perfect Substitutes, Perfect Complements, Imperfect SubstitutesCoke,


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Berkeley ECON 100A - Consumer Choice

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