Consumer Behavior Lecture Notes

These flashcards cover key concepts and terms related to consumer behavior as outlined in the lecture notes.

Consumer Behavior

Theory of how consumers allocate incomes among different goods and services to maximize their well-being.

Consumer Preferences

Assumptions in economics that preferences are given, consumers are rational, have goals, and make decisions to achieve those goals.

Market Basket

A list containing specific quantities of one or more goods.

Indifference Curve

A curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction.

Indifference curve in the pic

Shows all baskets that give the consumer the same level of satisfaction as does basket Baskets A, B and D, etc.

This consumer prefers: E, to A, A to H or G

Marginal Rate of Substitution (MRS)

Maximum amount of a good that a consumer is willing to give up to obtain one additional unit of another good. → The magnitude of the slope of an indifference curve

MUx/MUy=MRS(slope of indifference curve)=px/py

How much extra happiness do I get for every dollar I spend on this good?”

MU/dollar (mu per dollar)

Interior solution

: buy some of both goods; slope of indifference curve = slope of budget line.

Corner solution

• Is the solution to the consumer choice when the optimal solution is not the tangency.

- Situation in which the marginal rate of substitution of one good for another in a chosen market basket is not equal to the slope of the budget line

Usually happens with perfect substitutes or very strong preferences.

buy all of one good, zero of other

Marginal utility

Additional satisfaction obtained from consuming one additional unit of a good.

Utility Function

A mathematical representation that assigns a level of utility to individual market baskets. → ) can be represented by a set of indifference curves, with numerical indicators

Ordinal utility function

Utility function that generates a ranking of market baskets in order of most to least preferred

Cardinal Utility Function

Utility function that describes how much one market basket is preferred to another.

Smooth symmetric utility function

U(X,Y) = XY, or U(X,Y) = X^aY^b, where a and b are positive constants.

Perfect substitutes utility function (linear)

Utility function where one good can be substituted for another at a constant rate, represented as U(X,Y) = aX + bY, with a and b being positive constants.

Perfect compliments utility function

Utility function where goods are consumed together in fixed proportions, represented as U(X,Y) = min(aX, bY), with a and b being positive constants.

Quasi linear utility function 

Utility function where one good is linear in consumption and the other good's utility does not affect the marginal rate of substitution, represented as U(X,Y) = X + f(Y), with f being a function of Y.

U(X,Y) = X^0.5 + Y/4

Consumer choices

how one allocates their income

Budget Constraints

Constraints that consumers face due to limited incomes, determining what goods they can afford.

When the MRS diminishes along an indifference curve, the curve is

going through convexity

Budget Line

All combinations of goods for which the total amount spent is equal to income.

Px​⋅X+Py​⋅Y=I

Where:

• Px = price of good X

• Py = price of good Y

• X = quantity of good X

• Y= quantity of good Y

• I = income

The slope of budget line

−PF/PC

Price change

• A change in the price of one good (I unchanged)

causes the budget line to rotate about one intercept

Price of food falls from $1.00 to

$0.50 => The budget line rotates

from L1 to L2.

Price increases from $1.00 to $2.00,

=> The budget the line rotates from

L1 to L3.

the budget line and indifference curve are tangent

: MRS between the two

goods equals the price ratio (slope of budget line)

Consumer choice

Should satisfy two conditions:

1. Be on the budget line (the indifference curve should be tangent)

2. Maximize utility

Satisfaction is maximized

• when the marginal benefit — the benefit associated with the consumption of one additional unit of food — is equal to the marginal cost — the cost of the additional unit of food. (The marginal benefit is measured by the MRS

Diminishing Marginal Utility

As more of a good is consumed, the addition to utility from consuming additional amounts will be smaller.

Corner Solution

Situation where the optimal solution is not the tangency; the consumer only consumes one of the goods.

Indifference Map

Graph containing a set of indifference curves showing the baskets among which a consumer is indifferent.

Indifference map in pic

describes a person's preferences.

Any market basket on U3, (A), is preferred to any basket on U2 (B), which in turn is preferred to any basket on U1, (D).

Completeness

Assumption that consumers can compare and rank all possible market baskets.

Nonsatiation

Assumption that more of any good is preferred to less; consumers are never satisfied.

transivity

Consumers prefer basket A to basket B and basket B to
basket C, then the consumer also prefers A to C.
- Necessary for consumer consistency.

Perfect substitutes 

• MRS is constant.- The consumer views orange juice and apple juice as perfect substitutes: is always indifferent between a glass of one and a glass of the other.

•  When two goods can be substituted for one another with no change in utility. 

• 1 glass of orange juice is exactly as good as 1 glass of apple juice.

• A situation where two goods can replace each other in consumption without affecting the overall satisfaction of the consumer.

Perfect compliments

• MRS is zero or infinite;-

• The consumer views left shoes and right shoes as perfect complements:

• An additional left shoe gives no extra satisfaction unless without the matching right shoe.

• goods that a consumer always wants to consume together in fixed proportions.

• the only way to get more utility is to increase both goods together in the fixed ratio.