Consumer Behaviour in Microeconomics, Summaries of Consumer Behaviour

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Chapter 3:

Consumer Preferences

and the Concept of Utility

Outline



Introduction



Description of consumer preferences



The Utility functions



Marginal utility and diminishing marginal utility



Indifference curves



Marginal rate of substitution



Special functional forms



We need to develop a model about individual or

consumer behavior



Model is based on:

1. Individual tastes or preferences determine the amount of

pleasure people derive from goods and services.

(Chapter 3)

2. Consumers face constraints (budget) that limit their

choices

3. Consumers maximize their well-being or pleasure from

consumption, subject to the constraints they face.



We want our model to be realistic so we can

predict consumer behavior. But, still as simple as

possible.

Introduction

Description of Consumer

Preferences

Consumer Preferences tell us how the consumer

would rank any two basket of goods, assuming

these allotments were available to the consumer at

no cost.

baskets or bundles is a collection of goods or

services that an individual might consume.

Properties of Consumer

Preferences

3. Monotonic (more is better) Preferences: are

monotonic if a basket with more of at least one good

and no less of any good is preferred to the original

basket.

• free disposal can’t be worse of with more



The more is better assumption is also known as the property

of non-satiation.



It assumes are looking at what economists call a ‘good’.

Something we want more of



We are not looking at a ‘bad’ i.e. pollution



We can relax this assumption it is the first two that are

crucial for the analysis

Preferences Examples

Which bundles are better because more is better?

Ordinal vs Cardinal Rankings



Ordinal Ranking: gives us information on how a

consumer ranks different baskets of goods. But it

does not say by how much (i.e. 2 times as much)



This is how we view preferences.



Cardinal Rankings: Give us information on the

intensity of the consumer preferences (i.e. they like

basket A 10 times more than basket B).



Would be hard to say I like eating pizza out 10.5 times

more than eating bad Chinese. Putting an exact number to

our preferences is hard! – this is why we use ordinal

rankings for consumer preferences

Ordinal vs Cardinal Example

Students take an exam. After the exam, the students

are ranked according to their performance.

An ordinal ranking lists the students in order of their

performance (i.e., Harry did best, Joe did second

best, Betty did third best, and so on).

A cardinal ranking gives the grade of the exam, based

on an absolute grading standard (i.e., Harry got 50,

Joe got 100, so Joe did 2 times better than Harry).

Utility Functions



Difference in magnitudes of utility have no

interpretation per se



utility not comparable across individuals



any transformation of a utility function that

preserves the original ranking of bundles is an

equally good representation of preferences.

14

Utility Function (one good in

utility)

Are the assumptions on preferences

meet?

U(y) = y

.

y, weekly consumption of muffins

U(y): total

utility of

muffins

A

B

C

Slopes on A and C give marginal utility – each additional unit makes

person happy but by less than the previous unit

Marginal Utility (more than

one good)



The marginal utility : of a good, x, is the additional utility

that the consumer gets from consuming a little more of x

when the consumption of all the other goods in the

consumer’s basket remain constant.

U/x (y held constant) = MU

x

=∂ U/∂ x

U/y (x held constant) = MU

y

=∂ U/∂ y



…or…the marginal utility of x is the slope of the utility

function with respect to x.



The principle of diminishing marginal utility : states that

the marginal utility falls as the consumer consumes more

of a good

Marginal Utility

y, weekly consumption of muffins

MU(y):

marginal

utility of

muffins

-If more is always better: marginal utility

must always be positive.

-Diminishing marginal utility

-A positive marginal utility means you like

the good. Otherwise you would get zero or

perhaps negative marginal utility

IC

1

for U=

food

Clothing

Indifference Curve (IC)

2 good graph (keeps it simple)

• Along curve consumer is

indifferent between each of the

bundles of food and clothing

Same level of utility for bundle

A, B, and C

A

B

C

20

IC

1

for U=

IC

2

for U = 6

Food

Clothing

Preference direction ( happier

the further away from the

origin)

Are indifferent to any bundle along an

indifference curve. But more is better so

are better off as we move away from

the origin.

Indifference Map: