Consumer Decision Making Midterm 1

Positive Economics

Describes "what is" — factual, testable statements

Normative Economics

Prescribes "what ought to be" — involves value judgments and policyrecommendations

Complete Preferences

Individuals know all their preferences

Knowledge of All Options

Every alternative is known

Ranking Ability

Individuals can rank all available choices.

Consistency (Transitivity

If A ≻ B and B ≻ C, then A ≻ C

Complete Information / No Uncertainty

All outcomes and payoffs are known

Utility Maximization

Choose the option that gives the highest utility subject to constraints

Diminishing Marginal Utility

Each additional unit of a good provides less additional satisfaction than the previous one

Cardinal vs. Ordinal Utility

Cardinal utility assigns numbers to utility levels; ordinal ranks preferences without measuring exact differences

Objective Function and Constraints

Formal representation of a goal (e.g., maximize utility) under constraints (e.g., budget)

Multi‑Dimensional Objective Functions

Include utility derived from multiple sources,such as satisfaction gained from others' well‑being

Perishable

Goods that are consumed quickly and "expire"

Durable Goods

Goods that provide benefits over time.

Rival Goods

Goods that only one person can consume at a time

Excludable Goods

Anyone can consume, as long as they purchase it

Private goods

Rival & excludable

Public goods

Non‑rival & non‑excludable

Common resources

Rival but non‑excludable

Club goods

Non‑rival but excludable

Where are decisions made

Margin

When does optimal choice occur

Where marginal benefit (MB) equals marginal cost (MC)

Price Elasticity of Demand

Measures responsiveness of demand to price changes

Elastic (>1)

Demand responds strongly (often luxuries)

Inelastic (<1)

Demand responds weakly (often necessities)

Income Elasticity of Demand

- Normal goods: demand rises as income rises

- Inferior goods: demand falls as income rises

Cross‑Price Elasticity

- Substitutes: elasticity > 0

- Complements: elasticity < 0

Decision Trees

Visual representation of sequential decisions and outcomes

Expected Value

Probability‑weighted average payoff

Unraveling

Using backward induction to identify the best choice at each stage