Consumer

Behavior
CHAPTER 3 OF PINDYCK
The Theory of Consumer Choice

 Description of how consumers allocate incomes among different

goods and services to maximize their wellbeing
 Three steps to understand consumer behavior:
1. Consumer Preferences
2. Budget Constraints
3. Consumer Choices
Consumer Preferences
 Market Basket – (or bundle) is a list with specific quantities of one or more
goods.
Some Basic Assumptions about Preferences

1. Completeness – means that consumers can compare and rank

bundles. Ex. If Juan prefers Orange over an Apple or Apple over an
Orange or indifferent between the two.
2. Transitivity- means that if a consumer prefers basket A to B, and B to
C, then the consumer prefers A to C.
3. More is better than less- consumers prefers more of any good to
less.
Individual Preferences
Indifference Curves

indifference curve- are curves representing all combinations of market baskets that
provide a consumer with the same level of satisfaction.
Indifference Maps
The Shape of Indifference Curves

marginal rate of substitution (MRS)- is the maximum amount of a good that a

consumer is willing to give up in order to obtain one additional unit of another good.
Convexity

 Diminishing Marginal Rate of Substitution

 Indifference curves are usually bowed inward.
 The term convex means that the slope of the indifference curve
increases (i.e., becomes less negative) as we move down along the
curve. In other words, an indifference curve is convex if the MRS
diminishes along the curve.
Perfect Substitutes and Perfect
Complements
perfect substitutes- two goods
for which the marginal rate of
substitution(MRS) 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.
Budget Constraints

 budget constraints- the constraints that consumers face as a result

of limited incomes.
 budget line- all combinations of goods for which the total amount
of money spent is equal to income.
 Suppose, for example, that our consumer has a weekly income of
$80, the price of food is $1 per unit, and the price of clothing is $2
per unit. Table 3.2 shows various combinations of food and clothing
that she can purchase each week with her $80.
The Effects of a Change in Income
on the Budget Line
The Effects of a Change in Prices
on the Budget Line
Consumer Choice
Maximizing Consumer Satisfaction

 The maximizing market basket must satisfy two conditions:

1. It must be located on the budget line.
2. It must give the consumer the most preferred combination of goods
and services.

MRS = PF /PC
Note: Satisfaction is maximized when the marginal rate of substitution (of F
for C) is equal to the ratio of the prices (of F to C). Thus, the consumer can
obtain maximum satisfaction by adjusting his consumption of goods F and
C so that the MRS equals the price ratio.