Consumer Choice

Individual tastes or preferences determine the amount of pleasure people derive from the
goods and services they consume.
Consumers face constraints or limits on their choices.
Consumers maximize their pleasure from consumption, subject to the constraints they face.
The properties of consumers preferences:
o The completeness property holds that, when facing a choice between any two bundles
of goods, Bundles a and b, a consumer can rank them so that one of the following
relationships is true: a to b, b to a, and a ~ b.
o The transitivity property eliminates the possibility of certain types of illogical
behaviour. For example, if a consumer prefers a to b and b to c, then he must also
prefer a to c.
o The more-is-better property states that, all else the same, more of a commodity is
better than less of it.
A good is a commodity for which more is preferred to less, at least at some levels of
consumption.
A bad is something for which less is preferred to more, e.g. pollution.
An indifference curve illustrates the set of all bundles of goods that a consumer views as
being equally desirable.
An indifference map refers to the complete set of indifference curves that summarize a
consumers tastes or preferences.
Indifference curve maps must have the following four properties:
1. Bundles on indifference curves farther from the origin are preferred to those on
indifference curves closer to the origin.
2. There is an indifference curve through every possible bundle as a consequence of the
completeness property: The consumer can compare any bundle to another.
3. Indifference curves cannot cross. That is, a given bundle cannot be on two indifference
curves.
4. Indifference curves slope downwardotherwise, the more-is-better property is violated.
The marginal rate of substitution refers to the maximum amount of one good a
consumer will sacrifice to obtain one more unit of another good.
If an indifference curve is concave, the consumer would be willing to sacrifice more of one
good to obtain another, the fewer the former good the consumer has.
Perfect substitutes are goods that a consumer is completely indifferent as to which to
consume.
Perfect complements are goods that a consumer is interested in consuming only in fixed
proportions.
Utility refers to a set of numerical values that reflect the relative rankings of various
bundles of goods.
The utility function shows the relationship between utility values and every possible
bundle of goods.
An ordinal measure is one that tells us the relative ranking of two things but no how much
more one rank is than another.
The marginal utility is defined as the extra utility that a consumer gets from consuming
the last unit of a good.
The MRS is the negative ratio of the marginal utility of one good to the marginal utility of
another good.

The budget line (or budget constraint) illustrates the bundles of goods that can be
bought if the entire budget is spent on those goods at given prices.
The opportunity set refers to all the bundles of goods a consumer can buy, including all
the bundles inside the budget constraint and on the budget constraint.
The opportunity set increases when the price of one of the goods increases. This is because
more of one good can be consume with the same amount of income.
The slope of the budget line is called the marginal rate of transformation: the trade-off
the market imposes on the consumer in terms of the amount of one good the consumer
must give up to purchase more of the other good.
If the consumers income increases, the consumer can buy more of all goods. This effect is
shown by an outward shift of budget line.
The optimal bundlethe consumers optimummust lie on the budget constraint and be
on an indifference curve that does not cross it.
There are two solutions to solving the problem: the first is an interior solution, in which
the bundle has positive quantities of both goods and lies between the ends of the budget
line. The other possibility, called a corner solution, occurs when the optimal bundle is at
one end of the budget line, where the budget line forms a corner with one of the axes.
Interior solution:
o The utility of a consumer is maximized at the bundle where the rate at which he is
willing to trade one good to another equals the rate at which he can trade.
Corner solution:
o Some consumers choose to buy only one of the two goods. They so prefer one good to
another that they only purchase the preferred good.
o The indifference curve is not tangent to the budget line.
If indifference curves have both concave and convex sections, the optimal bundle lies in a
convex section or at a corner.
Behavioral economics adds insights from psychology and empirical research on human
cognition and emotional biases to the rational economic model.
Childrens lack of transitivity or rationality provides a justification for political and
economic restrictions and protections placed on young people.
The endowment effect states that people place a higher value on a good if they own it
than they do if they are considering buying it.
Economists use the term salience, in the sense of striking or obvious, to describe this idea,
e.g. tax salience is awareness of a tax.