Consumer Behavior:Consumer Preferences, Indifference curves

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Microeconomics ECO402

Lesson 6

Consumer Behavior

The explanation of how consumers allocate their resources (income) to the purchase of

different goods and services to maximize their well being.

There are three steps involved in the study of consumer behavior.

1) We will study consumer preferences.

· To describe how and why people prefer one good to another.

2) Then we will turn to budget constraints.

· People have limited incomes.

3) Finally, we will combine consumer preferences and budget constraints

to determine consumer choices.

· What combination of goods will consumers buy to maximize their

satisfaction?

Consumer Preferences

· Market Baskets

A market basket is a collection of one or more commodities.

· One market basket may be preferred over another market basket containing a

different combination of goods.

· Three Basic Assumptions

1) Preferences are complete.

2) Preferences are transitive.

3) Consumers always prefer more of any good to less.

Market Basket

Units of Food

Units of Clothing

Indifference curves represent all combinations of market baskets that provide the

same level of satisfaction to a person.

Clothing

The consumer prefers

(units per week)

A to all combinations

in the blue box, while

all those in the yellow

box are preferred to A.

Food

(units per week)

Microeconomics ECO402

Clothing

Combination B,A, & D

(units per

yield the same satisfaction

week) 50

·E is preferred to U

·U is preferred to H & G

Food

(units per week)

Indifference Curves

Indifference curves slope downward to the right.

· If it sloped upward it would violate the assumption that more of any

commodity is preferred to less.

Any market basket lying above and to the right of an indifference curve is

preferred to any market basket that lies on the indifference curve.

An indifference map is a set of indifference curves that describes a person's

preferences for all combinations of two commodities.

Each indifference curve in the map shows the market baskets among which the

person is indifferent.

Clothing

(units per

Market basket A

week)

is preferred to B.

Market basket B is

preferred to D.

Food

(units per week)

Microeconomics ECO402

Indifference Curves

Finally, indifference curves cannot cross.

· This would violate the assumption that more is preferred to less.

Indifference Curves

Clothing

Cannot Cross

(units per week)

The consumer should

be indifferent between

A, B and D. However,

B contains more of

both goods than D.

Food

(units per week)

Observation: The amount

Clothing 16

of clothing given up for

(units

a unit of food decreases

per week) 14

from 6 to 1

12 -6

-4

-2

1 -1

Food

(units per week)

The marginal rate of substitution (MRS) quantifies the amount of one good a consumer

will give up to obtain more of another good.

It is measured by the slope of the indifference curve.

Clothing

(units

per week)

MRS = - ΔC

MRS = 6

ΔF

-6

-4

MRS = 2

-2

1 -1

Food

(units per week)

Microeconomics ECO402

We will now add a fourth assumption regarding consumer preference:

Along an indifference curve there is a diminishing marginal rate of substitution.

· Note the MRS for AB was 6, while that for DE was 2.

Marginal Rate of Substitution

Indifference curves are convex because as more of one good is consumed, a

consumer would prefer to give up fewer units of a second good to get additional

units of the first one.

Consumers prefer a balanced market basket

Perfect Substitutes and Perfect Complements

· Two goods are perfect substitutes when the marginal rate of substitution

of one good for the other is constant.

Apple

Juice

Perfect

(glasses

Substitutes

)

Orange Juice

(glasses)

Two goods are complements when the indifference curves for the goods

are shaped as right angles.

Left

Shoes 4

Perfect

Complements

Right Shoes

BADS

Things for which less is preferred to more

Example

Air pollution

Designing New Automobiles

Automobile executives must regularly decide when to introduce new models

and how much money to invest in restyling.

An analysis of consumer preferences would help to determine when and if car

companies should change the styling of their cars.

Microeconomics ECO402

Consumer

Styling

Preference A:

High MRS

These consumers are

willing to give up

considerable

styling for additional

performance

Performance

Consumer

Preference B:

Styling

Low MRS

These consumers are

willing to give up

considerable

performance for

additional styling

Performance

Designing New Automobiles

What Do You Think?

· How can we determine the consumers preference?

Designing New Automobiles

A recent study of automobile demand in the USA shows that over the past two

decades most consumers have preferred styling over performance.

Growth of Japanese Imports

1970's and 1980's

· 15% of domestic cars underwent a style change each year

· This compares to 23% for imports

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