1. MICROECONOMICS: Theory & Applications Chapter 3 The Theory of Consumer Choice
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
9th Edition, copyright 2006
PowerPoint prepared by Della L. Sue, Marist College

2. Learning Objectives
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.
Understand 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.
(Continued)
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3. Learning Objectives (continued)
Determine how changes in income affect consumption choices.
Show how altruism can be explained by the theory of consumer choice.
Relate the utility approach to the indifference curve method of analyzing consumer choice.
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4. 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.
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5. Definitions
Indifferent – when a consumer finds two options to be equally satisfactory
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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6. Consumer Preferences Graphed as Indifference Curves
Indifference curve – plots all the market baskets that a consumer views as being equally satisfactory
Figure 3.1
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7. Characteristics of Indifference Curves
An indifference curve has a downward slope if the good is 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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8. Curvature of Indifference Curves
Indifference curves are convex to the origin.
Why?
Diminishing marginal rate of substitution: a consumer’s willingness to give up less and less of some other good to obtain still more of the first good
Figure 3.4
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9. Individuals Have Different Preferences [Figure 3.5]
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10. Graphing Economic Bads and Economic Neuters [Figure 3.6]
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11. Perfect Substitutes and Complements [Figure 3.7]
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12. The Budget Constraint [Figure 3.8]
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13. Geometry of the Budget Line
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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14. Shifts in Budget Lines
A change in income with constant prices produces a parallel shift in the budget line.
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.
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15. The Consumer’s Choice Marginal benefit Marginal cost
The value the consumer derives from consuming one more unit of a good
Measured by the MRSXY
Marginal cost
The cost of consuming one more unit of a good
Measured by the price ratio
Consumer’s optimal choice
MRSXY = PX/PY
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16. A Corner Solution
The consumer’s optimal choice is not characterized by an equality between the MRS and the price ratio.
Figure 3.12
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17. The Composite-Good Convention [Figure 3.13]
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18. Changes in Income and Consumption Choices
Income-consumption curve: the curve that joins all the optimal consumption points generated by varying income
The curve slopes upward for normal goods.
Figure 3.14
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19. Income-consumption Curve for an Inferior Good
The curve slopes downward for normal goods.
Figure 3.15
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20. The Food Stamp Program [Figure 3.16]
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21. Are People Selfish? [Figure 3.18]
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22. The Utility Approach to Consumer Choice
Total utility - assuming that it is measurable, the total satisfaction a consumer receives from a given level of consumption
Marginal utility - the amount by which total utility rises when consumption increases by one unit
Diminishing marginal utility – the assumption that as more of a given good is consumed, the marginal utility associated with the consumption of additional units tends to decline, other things equal.
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23. The Consumer’s Optimal Choice
The utility-maximizing market basket is one for which the consumer allocates income so that the marginal utility divided by the good’s price is equal for every good purchased:
MUX/PX = MUY/PY
The equality between the marginal utility per dollar’s worth of both goods is the same as the equality between the MRS and the price ratio.
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24. Copyright 2006 John Wiley & Sons, Inc. All rights reserved
Copyright 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein.
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