Consumer theory:

Preferences, consumption and

demand.
Alexia Gaudeul
GSBC Basics Week
“Friends”

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Value and Utility in
“Friends”

• In “Friends”, series 2, episode 6,

Phoebe who played guitar for free at
“Central Perk”, is replaced by a
“professional” musician.1
• Jealous Phoebe decides to sing in the
street and collect alms from
passerby’s. She gets depressed when
her favorite song “Smelly Cat” earns
only $0.50. 1 This turns out to be Chrissie Hynde of The Pretenders,
who performs "Angel of the Morning" on acoustic guitar.
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Value and Utility in
“Friends”

• Ethics: Why should Phoebe not be paid

when a “professional” musician doing the
same job is?
• Psychology: Why does Phoebe refuse to
go on not being paid?
• Sociology: What makes one a
“professional” musician?
• Law: Should one need a license to play
music?
• Economics: What is the value of Phoebe’s
performance?

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What is the value of a
performance?

• Producer value:
– How many additional drinks can I sell by
having a musician?
• Performer value:
– Utility from playing vs. alternatives.
– Or intrinsic value = time in training? (Ricardo)
• Market value: How much are musicians
prepared to accept to play? How much are
bar owner prepared to play? How do they
negotiate?
• How do I reconcile all those values?

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Consumer theory

• Start from consumer preferences

among goods.
• Find out their consumption of those
goods.
• Determine how this translates into
market demand.
• All this based on price of the goods
and wealth of the consumer.

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Bread and Butter

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A bread-and-butter issue

• An issue that is central or fundamental to

one's business, survival, or income. For
example, an election campaign may say
“Our focus is going to be on bread-and-
butter issues”.
• How much butter will I put on my bread
and why?
• What happens if the price of bread and
butter change?

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Bread OR Butter?

• 100 g of bread (baguette) = 263 kcal

• Price of a baguette: 1 euro
• Weight of a baguette: 250 g
–  1 euro = 657.5 kcal
• 100 g of butter = 700 kcal
• Price of butter: 1.5 euros
• Weight of a block of butter: 250 g
–  1 euro = 1166.7 kcal
•  Let them eat butter! (modified from
Marie-Antoinette’s “Let them eat cake!”).
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How much butter on my
bread?

• In practice, I use about 1 block of butter

for 4 baguettes (I like butter a lot!).
– So I consume 1.5 baguette kcal for each butter
kcal.
– Why? This is what I prefer.
• How do I represent and measure and
compare my preferences with others?
– U(Bread, Butter)=ABrαBuβ
– Br, Bu: Number of bread, resp. butter
calories…
– ln(U(Bread, Butter))=lnA+αln(Br)+βln(Bu)

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Iso-Utility Curves

• A=1, α=β=1/2
• Curve for U1=10
is such that
10=√Br√Bu
• Curve for U2=20
is such that
20=√Br√Bu
• Any point along
a line gives me
the same utility.

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The utility of bread and
butter

• Price of bread: pbread (per kilo-

calorie)=0.152 cents
• Price of butter: pbutter (per kilo-
calorie)=0.086 cents
• Wage: w (e.g. 2 euros/day).
• My “program” is:
– Max lnA+αln(Br)+βln(Bu)
– subject to: pbreadBr+pbutterBu<w
• Question: What is my α? What is my β?

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Alexia’s dieting program

– Max lnA+αln(Br)+βln(Bu)
– subject to: pbreadBr+pbutterBu < w

– Max lnA+αln(Br)+βln(Bu)
– λ(pbreadBr+pbutterBu-w)

– α/Br- λpbread=0
– β/Bu-λpbutter=0
– pbreadBr+pbutterBu=w

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Alexia’s α

– α/β = (Br*pbread)/(Bu*pbutter)
– pbread*Br+pbutter*Bu=w

– α/β=w/(pbutter*Bu)-1
– β/α=w/(pbread*Br)-1

– In my case, I consume 1.5 baguette kcal for each butter

kcal so Br=1.5*Bu

– Budget constraint: 0.152*1.5*Bu+0.086*Bu=200

–  Bu= 637 kcal  Br=955 kcal

– α/β=200/(0.086*637)-1=2.65
– β/α=200/(0.152*955)-1=0,38 (=1/2.65)

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Alexia = 2.65

• So, the reason I eat 1.45 baguette per

day, along with 36.4% of a block of
butter, is that my α/β=2.65.
• I enjoy (the logarithm of) bread 2.65
more than (the logarithm of) butter, which
explains why I don’t eat only butter even
though it is much cheaper per kcal.
• Question:
– What if my α/β increased?  change in
preferences
– What if my wage increased?  income effect
– What if the price of butter increased? 
substitution effect.
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Alexia = 2.65?

• I can compare my preferences with

others (though comparing utilities is
meaningless).
• What could change my α/β?
– Better bread?
– High cholesterol?
– What would be the consequences?

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Alexia = 2.65?

• What about the shape of my utility function?

• In my family, for example, we were forbidden
(for ethical reasons?) to have both jam and
butter superposed on the same piece of bread,
irrespective of anything including our best
arguments.
– Then I cannot write U(Bread, Butter, Jam)=ABrαBuβJaγ,
since it would lead to predictions that would not be
consistent with my behavior (though maybe with my
preferences?)
• In practice, I only know my preferences around
some point (local preferences), in so far as they
explain my reaction to (small) price changes.

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2.65 = losing weight

• I am supposed to need 2000 kcal/day to

maintain my weight while given my salary,
prices and preferences, I get only 1592
kcal/day.
– I would lose 500 g per week with this diet,
though this rate of decrease would decrease
after a while, so in the end I would probably
be able to survive on this (Basal Metabolic
Rate).
– e.g. the official ration in the U.S. zone for
German citizens in May 1946 was no more
than 1275 kcal/day, though this had increased
to 2000+ by 1948.

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Potatoes rather than bread

• Therefore, I will actually have to spend my

2 euros in such a way that I get at least
2000 kcal.
• I need to sacrifice a bit of bread for butter
such that:
– Br+Bu>2000
– subject to: pbreadBr+pbutterBu<w
– Br=424 kcal  2/3 of a baguette
– Bu=1576 kcal  90% of a block of butter
• Now, I look like I don’t like bread that
much!

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Potatoes rather than bread

• Maybe I could switch to potatoes?

(Antoine-Augustin Parmentier)
– 1 Jacket potato = 180g = 245 kcal
– 1 kg potatoes, which cost 1 euro, provides
1361 kcal, twice as much as bread!
– I should thus be able to satisfy my needs with
butter + potatoes rather than bread + butter.
• Note: Parmentier tried to make bread out
of potatoes in order for it to gain
acceptance among the French, but it was
famine in the early 1770s that established
it into their diet.

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What are preferences?

• In the previous example, was 2.65 an

accurate measure of my preferences?
• To what extent are my preferences
dependent on my environment?
– E.g. my diet will likely differ if in France or if in
Germany.
• To what extent does my environment
depend on my preferences?
– E.g. a country with a large butter consumption
will likely have a large dairy industry.
– Does that means dairy prices will be lower?

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“True” preferences?

• Given an environment, how can I

retrieve my “true” preferences?
– Revealed preferences? (observe what I
do)  this is what we did up to now.
– Stated preferences? (ask me what I
would like to do)

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Preferences for non-market
goods

• What about the value of clean air and

water, healthy fish and thriving wildlife
populations?
• Not priced, difficult to measure their
consumption  difficult to measure
consumers’ preferences w.r.t. those goods
according to previous method.
– What is the value of a green park? The number
of times you go jogging there?
– If you have never been to a beach, does that
mean you don’t value their cleanliness?

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Central Park

New York’s Central Park’s estimated value is 529 billion dollars (as
estimated by how much it could be sold for to property developers) 
about $70,000 per inhabitant, or about 10 times NYC‘s annual budget.

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Methods

• Contingent valuation: use surveys to

directly elicit individuals' preferences
and willingness to pay for a good.
– E.g. the value of a green park is the
sum of how much people would be
prepared to pay to preserve it.
– Problem: Difference between WTP and
WTA, confusion over the question, little
account of budget constraints…

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Methods

• Hedonic Pricing: treat market

goods/services as a bundle of attributes
and decompose market prices into
“shadow prices” (i.e., values) for
individual attributes.
– E.g. the value of a green park is how much
money I save on a sport club membership.
– The value of environmental regulation of food
production is how much I am prepared to pay
for bio-certified products vs. others.

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Methods

• I can also look at how much would

be lost in economic activity if I got
rid of the green park, by using data
from other cities.
– E.g. if Central Park disappeared, how
much would surrounding properties lose
in value? How many companies would
switch headquarters? What about health
measures (long term impact).

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Green park

• Social values  free access, neutral

ground.
• Environmental values  biodiversity,
micro-climate, reduced pollution.
• Economic value  value of nearby
houses, decrease in health bills,
employment.

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