Consumer Choice Perloff Chapter 4 Introduction Demand curve –As price of a good increases we buy less of it. Consumers are making a choice What governs.

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Presentation transcript:

Consumer Choice Perloff Chapter 4

Introduction Demand curve –As price of a good increases we buy less of it. Consumers are making a choice What governs the ways in which these choice are made Preferences are central

Assumptions Completeness –Given any two bundles consumer can always rank them or say he/she is indifferent. Transitivity –If bundle 1 is preferred to bundle 2 and bundle 2 is preferred to bundle 3 this implies that 1 is preferred to 3. More is better –Bundles containing more of all goods are preferred

B, Burritos per semester Z, Pizzas per semester d a b e c f A B Source: Perloff Using transitivity to construct an preference map

B, Burritos per semester Z, Pizzas per semester d a b I e c f Indifference Curve

B, Burritos per semester Z, Pizzas per semester d I 0 I 1 I 2 e c f Properties 1 and 2 Indifference curves further away from the origin are preferred. There is an indifference curve through every bundle

B, Burritos per semester Z, Pizzas per semester I 1 I 0 a b e Property 3 Indifference curves cannot cross

B, Burritos per semester Z, Pizzas per semester I a b Property 4 Indifference curve slope downwards

B, Burritos per semester – –2 – Z, Pizzas per semester a b c d I Property 5 Indifference curves are convex to the origin

B, Burritos per semester Z, Pizzas per semester a d I Marginal Rate of Substitution How many burritos will be exchanged for 1 Pizza -6 3

Coke, Cans per week 1234 Pepsi, Cans per week I 1 I 2 I 3 I 4 Perfect Substitutes A B C

Ice cream, Scoops per week 123 Pie, Slices per week I 1 I 2 I 3 a d ec b Perfect Complements

Food at home per year Clothing per year I 4 I 3 I 2 I 1 Indifference Curves between Food and Clothing, What is happening?

Utility Indicates the position of a bundle of goods in the consumers preference ordering. Higher ranking implies higher utility. Preferences are fundamental. Utility is a simply a useful way of summarising preferences.

Utility Function BZU Mathematical relationship between the quantities of the goods and the level of utility.

Marginal Utility The change in utility when the consumption of a good changes by one unit U, Utils  U = 20 Utility function, U (10,Z )  Z = Z, Pizzas per semester

Diminishing marginal utility, MarginalMU Z utility of pizza MU Z Z, Pizzas per semester

Budget Constraint A person spends £50, burritos cost £2 and pizzas cost £1, they buy 10 pizzas, how many burritos can they buy? Cost of Pizzas: Money left for burritos: Number of Burritos: In general: Intercept Slope (MRT)

B, Burritos per semester Opportunity set 50= Y/p Z L 1 (p Z = £1,Y = £50) 25 = Y/p B Z, Pizzas per semester a b c d Opportunity Set

B, Burritos per semester Loss 50 L 1 (p Z = £1) L 2 (p Z = £2) 25 0 Z, Pizzas per semester Increase in Price

B, Burritos per semester Gain 100 L 3 (Y = £100) L 1 (Y = £50) Z, Pizzas per semester Income Increases

The optimal choice B, Burritos per semester Budget line Z, Pizzas per semester I 1 I 2 I 3 d fc e a g A B

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