Microeconomics 3
Consumer Behavior
Consumer Behavior
theory of consumer behavior
Description of how consumers allocate incomes among different goods and
services to maximize their well-being.
3 steps of consumer behavior
1. Consumer preferences
2. Budget constraints
3. Consumer choices
market basket
List with specific quantities
of one or more goods.
3 assumptions of consumer 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.
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.
indifference curve
Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction.
indifference map
Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent
marginal rate of substitution (MRS)
Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good. (slope of indifference curve)
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.
utility
Numerical score representing the satisfaction that a consumer gets from a given market basket.
utility function
Formula that assigns a level of utility to individual market baskets
budget line
All combinations of goods for which the total amount of money spent is equal to income.
P(food)*Q(food) + P(clothes)*Q(clothes) = I
2 conditions of maximizing market basket
1. It must be located on the budget line.
2. It must give the consumer the most preferred combination
of goods and services.
marginal benefit (MRS)
Benefit from the consumption of one additional unit of a good.
(satisfaction is maximized when equal to marginal cost)
marginal cost
Cost of one additional unit of a good.
corner solution
Situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line.
marginal utility
Additional satisfaction obtained from consuming one additional unit of a good.
diminishing marginal utility
Principle that as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility
equal marginal principle
Principle that utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods.
cost-of-living index
Ratio of the present cost of a typical bundle of consumer goods and services compared with the cost during a base period.
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Cartes-fiches
theory of consumer behavior
Description of how consumers allocate incomes among different goods and
services to maximize their well-being.
3 steps of consumer behavior
1. Consumer preferences
2. Budget constraints
3. Consumer choices
market basket
List with specific quantities
of one or more goods.
3 assumptions of consumer 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.
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.
indifference curve
Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction.
indifference map
Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent
marginal rate of substitution (MRS)
Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good. (slope of indifference curve)
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.
utility
Numerical score representing the satisfaction that a consumer gets from a given market basket.
utility function
Formula that assigns a level of utility to individual market baskets
budget line
All combinations of goods for which the total amount of money spent is equal to income.
P(food)*Q(food) + P(clothes)*Q(clothes) = I
2 conditions of maximizing market basket
1. It must be located on the budget line.
2. It must give the consumer the most preferred combination
of goods and services.
marginal benefit (MRS)
Benefit from the consumption of one additional unit of a good.
(satisfaction is maximized when equal to marginal cost)
marginal cost
Cost of one additional unit of a good.
corner solution
Situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line.
marginal utility
Additional satisfaction obtained from consuming one additional unit of a good.
diminishing marginal utility
Principle that as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility
equal marginal principle
Principle that utility is maximized when the consumer has equalized the marginal utility per dollar of expenditure across all goods.
cost-of-living index
Ratio of the present cost of a typical bundle of consumer goods and services compared with the cost during a base period.
