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Microeconomics ­ECO402
VU
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
A
20
30
B
10
50
D
40
20
E
30
40
G
10
20
H
10
40
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
B
in the blue box, while
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all those in the yellow
box are preferred to A.
H
E
40
A
30
D
G
20
10
Food
10
20
30
40
(units per week)
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Microeconomics ­ECO402
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Clothing
Combination B,A, & D
(units per
yield the same satisfaction
B
week) 50
·E is preferred to U
1
·U is preferred to H & G
H
E
40
1
A
30
D
20
U1
G
10
Food
10
20
30
40
(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.
D
B
A
U3
U2
U1
Food
(units per week)
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Microeconomics ­ECO402
VU
Indifference Curves
­  Finally, indifference curves cannot cross.
·  This would violate the assumption that more is preferred to less.
Indifference Curves
Clothing
Cannot Cross
U
(units per week)
U
The consumer should
be indifferent between
A, B and D. However,
B contains more of
A
both goods than D.
B
D
Food
(units per week)
A
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
10
B
1
8
-4
D
6
1
E
-2
G
4
1 -1
1
2
Food
1
2
3
4
5
(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.
A
Clothing
16
(units
per week)
MRS = - ΔC
14
MRS = 6
ΔF
-6
12
10
B
1
8
-4
D
MRS = 2
6
1
E
-2
G
4
1 -1
1
2
Food
1
2
3
4
5
(units per week)
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Microeconomics ­ECO402
VU
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
4
Juice
Perfect
(glasses
Substitutes
)
3
2
1
Orange Juice
(glasses)
2
0
1
3
4
Two goods are complements when the indifference curves for the goods
·
are shaped as right angles.
Left
Shoes 4
Perfect
Complements
3
2
1
1
2
3
4
0
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.
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Microeconomics ­ECO402
VU
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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