MicroEconomics theory and application 12th by browning an zupan chapter 03

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications

Chapter 3: The Theory of Consumer Choice
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives
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Develop an approach for analyzing consumer preferences.
Explain how a consumer’s income and the prices that must
be paid for various goods limit consumption choices.
Describe how the market basket chosen by a consumer
reflects both the consumer’s preferences and the budget
constraints imposed on the consumer by income and the
prices that must be paid for various goods.
Determine how changes in income affect consumption
choices.
(continued)

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Learning Objectives


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(continued)

Explain how altruism can be explained by the theory of
consumer choice.
Relate the utility approach to the indifference curve method
of analyzing consumer choice.
Explain the mathematics behind consumer choice.

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Develop an approach for analyzing consumer preferences.

3.1 CONSUMER PREFERENCES

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Consumer Preferences
Economists make three assumptions about the typical
consumer’s preferences:
 Preferences are complete.
 Preferences are transitive.
 More of any good is preferred to less.
 aka “nonsatiation”

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Definitions
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Indifferent – when a consumer finds two options to be
equally satisfactory
Market baskets – combinations of goods
Economic “bads” – commodities of which less is preferred
to more over all possible ranges of consumption
Economics “goods” – commodities of which more is better
than less

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Figure 3.1 – An Indifference Curve



Indifference curve – a plot
of all the market baskets
the consumer views as
being equally satisfactory

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Figure 3.2 - An Indifference Map

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Characteristics of Indifference
Curves
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Characteristics:
 An indifference curve has a downward slope if both
goods are desirable.
 An indifference curve that lies farther from the origin is
preferred to one that is closer to the origin.
 Two indifference curves cannot intersect.
An indifference map is a set of indifference curves.
A set of indifference curves represents an ordinal ranking.

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Figure 3.3 - Why Intersecting
Indifference Curves Are Inconsistent

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Marginal Rate of Substitution


“MRS”
 A measure of a consumer’s willingness to trade one good
for another
 The maximum number of one good the consumer is

willing to give up to obtain one more of another good
 Depends upon the initial endowment
 Related to the slope of an indifference curve

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Figure 3.4 - Curvature of Indifference
Curves
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

Indifference curves are
convex to the origin.
Why?
 diminishing marginal
rate of substitution
(MRS): a consumer’s
willingness to give up
less and less of some
other good to obtain
still more of the first
good

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Convexity of Indifference Curves
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Assumption
 both goods in the market basket are economic “goods”
Declining MRS
 pertains to a movement along a given indifference curve
 NOT to a movement from one curve to another
 slope of each curve becomes flatter as move down the
curve

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Individuals Have Different Preferences
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Indifference curves – indicate the relative desirability of
different combinations of goods

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Figure 3.5 – Indifference Map of Two

Consumers

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Categories of Goods
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“Good” – when more is preferred to less
“Bad” – when less is preferred to more
“Neuter” – when the consumer does not care about a
particular good
Perfect Substitutes – when a consumer is willing to
substitute one good for another at some constant rate and
remain equally well off
Perfect Complements – when goods must be consumed
in a precise combination in order for the consumer to
remain equally well off

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

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Figure 3.6 – Indifference Maps for a “Bad”
and a “Neuter”

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Figure 3.7 - Perfect Substitutes and
Complements

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Explain how a consumer’s income and the prices that must be paid for
various goods limit consumption choices.

3.2 THE BUDGET CONSTRAINT

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The Budget Constraint


Budget constraint – the way in which a consumer’s income
and the prices that must be paid for various goods limit
choices



Budget line - a line that shows the combinations of goods
that can be purchased at the specified prices and assuming
that all of the consumer’s income is expended.

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Figure 3.8 - The Budget Line


Budget line: a line that
shows the combinations of
goods that can be
purchased with a given
income.

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See Table 3.1 for data used
in graph. [next slide]

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Table 3.1 – Data used in Figure 3.8

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Geometry of the Budget Line
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The intercepts with the axes show the maximum amount of
one good that can be purchased if none of the other is
bought.
The slope indicates how much of one good must be given
up to buy one more of the other good:
Slope = ΔY/ΔX = -PX/PY

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Shifts in Budget Lines


Two underlying factors:
 Income Changes
 A change in income with constant prices produces a
parallel shift in the budget line.
 Price Changes
 A change in the price of one good, with income and
the other good’s price remaining unchanged, causes
the budget line to rotate about one of the intercepts.
 Indicative of change in real or relative prices

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Figure 3.9 - Effect of an Income Change
on the Budget Line

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