Prof.

Teresa Kamińska Microeconomics

dr Anna Blajer - Gołębiewska

3. CONSUMER BEHAVIOUR (THEORY OF CONSUMER CHOICE)

focuses on how consumers choose goods with limited recourses (constrained

optimization)
Consumer preferences and the concept of utility
Consumer preferences describe how an individual would rank (i.e. compare the
desirability of) any two baskets (bundles), assuming the baskets were available at no
cost.
Assumptions about consumer preferences taking for granted that consumers behave
rationally under most circumstances:
1. preferences are complete (consumer is able to rank any two baskets)
2. preferences are transitive (consumer makes choices that are consistent with each
other, i.e. if consumer prefers basket A to basket B and B to basket C it means
that basket A is preferred to basket C. Transitivity in algebraic notation can be
represented as follows: if A  B and if B  C, then A  C
3. more is better (having more is better for the consumer).

In theory it is not important to measure the amount of utility (satisfaction, pleasure) a

consumer receives from a basket. However, a cardinal ranking is often used to facilitate
exposition, an ordinal ranking explains sufficiently consumer’s decisions.

Utility functions – preferences with a single good

To illustrate the concept of a utility function, an assumption of only one good purchased
is relevant. If x denotes the number of smoothies per day and U(x) – the level of utility
derived from their consumption then having enough information to write down the
utility function, it is possible to assign values of each basket, satisfy the assumption that
more is better and compare (rank) intensities of various baskets.
TU
MU 
X
Quantity consumed Total utility Marginal utility Marginal utility
(x – smoothies) U(x) = 22x - x2 MUx= 22 - 2x
1 21 20 21
2 40 18 19
3 57 16 17
4 72 14 15
5 85 12 13
6 96 10 11
7 105 8 9
8 112 6 7
9 117 4 5
10 120 2 3
11 121 0 1
12 120 -2 -1

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

TU
U(x) = 22x - x2

72
A ΔTU= 14
58
Δx=1
(a)

0 1 2 3 4 5 6 7 8 9 10 11 smoothies

25

20

15

10

0
0 2 4 6 8 10 12 14
-5
smoothies per day

Marginal utility MUx= 22 - 2x Marginal utility

TU
The ratio is marginal utility (MU), it is the rate at which total utility
x
changes as the level of consumption changes (rises).

The example in the table and in the figures indicates that marginal utility declines as the
consumer drinks more smoothies. This trend illustrates the principle of diminishing
st
marginal utility (the I Gossen’s law – the more something is consumed the less
additional satisfaction is obtained from additional consumption holding all else
fixed).

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

Preferences with multiple goods

In real life consumers may choose among a great deal of goods. To study the trade offs a
consumer must make in choosing his/her optimal basket, it is necessary to examine the nature
of consumer utility with multiple products.

A consumer faces a choice between two types of commodities e.g. food and clothing

clothing
 Y
MRS 
X
c2 A

c1 B
U4
C E
D U3

U2
U1

0 f1 f2 f3 f4 f5 food

Each contour is called indifference curve because the consumer would be equally satisfied
with (or indifferent in choosing among) all baskets on the indifference curve. A set of
indifference curves is an indifference map.
Indifference curves on an indifference map share the following properties:
1. the further the curve’s position from the origin of coordinate system is, the
higher utility level it represents (more is better if only there is more of one
commodity in the basket (basket E  C)
2. when a consumer likes both goods (MUfood and MUclothing are both positive), the
indifference curves will have a negative slope
3. indifference curves cannot intersect
4. every consumption basket lies on one and only one indifference curve
5. indifference curves are not “thick”.

The slope of the indifference curve is a tool describing consumer’s willingness to

substitute one good for another. In economics, the term that describes the willingness to
substitute is the marginal rate of substitution (MRSf,c). Specifically, the marginal rate of
substitution of food for clothing (in general of x for y) is the rate at which the consumer
will give up clothing to get more food, holding the level of utility constant.
MRS for any basket can be expressed as a ratio of the marginal utilities of the goods in
that basket. Suppose the consumer changed the level of consumption of x and y by x
and y, respectively. The corresponding impact on utility U would be

U = MUx(x) + MUy (y)

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

Changes in x and y that move the consumer along the indifference curve U0 must keep
utility unchanged, so that U = 0:
MUx(x) +MUy(y) = 0

which can be rewritten - MUy(y) = MUx(x)

and solved for the slope of the indifference curve

y MU x
  MRS x , y
x holding utility constant MU y

Moving downward along the indifference curve MRS of x for y is lower and lower since
the consumer would be willing to forgo the fewer and fewer portions of y to get
additional unit of x. In that case the consumer’s preferences exhibit a diminishing
marginal rate of substitution of x for y. In other words, the MRS of x for y declines as the
consumer increases his/her consumption of x along an indifference curve.

Since shape, slope, and position of indifference curves reflect consumer’s preferences so
they represent a subjective approach to consumer behaviour.

Special utility functions

y y

U3

U2
U1 U2 U3 U1
x x
1
U = x + 2y MRSx,y = - 1/2 U = (x,y) = a min (x,y) MRSx,y = 0

perfect substitutes perfect complements

The goods are perfect substitutes when the MRS of one for the another is constant, but
not necessarily equal to – 1. Perfect complements are goods the consumer always wants
to consume in fixed proportion to each other, so MRS = 0.

Budget constraint

Consumer’s choice becomes objective with respect to income and market terms (prices).
The budget constraint defines the set of baskets that a consumer can purchase with a
limited amount of income, so the budget line indicates all of the combinations of food
and clothing that can be bought if the consumer spends all of his/her available income

1
The notation „min” means “take the minimum value of the two numbers in parentheses” and “a” is a constant
indicating the minimum utility level of the function.

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

on the two goods. If the consumer does not save any income it means that all total
expenditures equal his/her income:

I = Pf·F + Pc·C

Budget line can be expressed and plotted as:

PF
PC  C  I  PF  F  C
I PF
 F . Its slope =

PC PC PC

If income (I) is constant in nominal terms and

PC = constant PF  PF 
in real terms
I I
C I C
C=I/PC

I3 I2 I/PF
0 F3 F2 F1 F 0 F1 F2 F3 F

PF = constant PC PC

C1 C3

C2 C2

C3 C1

0 F 0 F

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

PC PF PC PF

real income ?
C C
C2
C1 I2
I1

C2 C1

I1
I2
0 F1 F2 0 F2 F1 F

PC and PF are constant

I I
C C

I1 I2 I2 I1
0 F 0 F

Optimal choice

Assuming that a consumer makes a choice rationally means he/she chooses a basket of
goods that:
 maximizes his/her utility while
 allowing him/her to live within his/her budget constraint in a given time.

The optimal choice problem for the consumer is expressed like this:
max U ( x, y)
( x, y )

subject to PX  x  Py  y  I

If the consumer likes more of both goods, the marginal utilities of both goods are
positive. At an optimal basket all income will be spent, so the consumer maximizes
utility by reaching the highest indifference curve while being on the budget line. This
means that the slope of the budget line and the slope of indifference curve are equal.
Therefore, at the optimal basket (E), the tangency condition requires that

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

MU x Px MU x MU y
 or 
MU y Py Px Py

In optimal basket the marginal utility per a spent unit of money (dollar, euro or
zloty) must be equal for all goods (the IInd Gossen’s law).

YE E
U4
U3

U2
A U1
I
0 XE X

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

Task
Kate’s income per week that she spends for goods A and B is 20 m.u. Their
prices, quantities Kate buys and utilities obtained from their consumption are
displayed in the table below.

Good Price in m.u. Quantity TU MU

A 0.75 20 500 45
B 0.50 10 1000 20

To attain maximum utility from consumption Kate should:

a) buy less A and more B
b) buy the same amount of A but more B
c) buy more A and less B
d) buy the same amount of B but more A
e) stay at the same basket of A and B as so far since it’s been the best choice.
MU A MU B
PA PB

Present the solution graphically.

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Prof. Teresa Kamińska Microeconomics
dr Anna Blajer - Gołębiewska

Deriving an individual demand curve

Holding income, preferences, and the prices of all other goods constant, how will a
change in the price of food affect the amount of food the consumer buys?

C PF

E3 P3 E’3
E2
E1 the PCC P2 E’2
U1 U2
U3 dF
I3 I2 I1 P1 E’1

0 F1 F2 F3 F 0 1,5 4 9 F
C PC
P3 E’3
I1 the price consumption curve

C3 I2 E1
U3 P2 E’2
C2 E2 U2
I3
C1 E3 U1 P1 E’1
dC
0 F 0 C1 C2 C3 C

Holding income and the price of Y constant the set of optimal bundles traced on
an indifference map by the various budget lines as the price of X varies is called
the price consumption curve (PCC).

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