Session 4 Consumer behavior and consumer preferences How

Session 4: Consumer behavior and consumer preferences Ø How are consumer preferences used to determine demand? Ø How do consumers allocate income to the purchase of different goods?

Session 4: Consumer behavior and consumer preferences Consumer Behaviour • The theory of consumer behaviour can be used to help answer above and many more questions • Theory of consumer behaviour – The explanation of how consumers allocate income to the purchase of different goods and services

Session 4: Consumer behavior and consumer preferences Consumer Behaviour • There are three steps involved in the study of consumer behaviour • Consumer Preferences – To describe how and why people prefer one good to another • Budget Constraints – People have limited incomes

Session 4: Consumer behavior and consumer preferences Consumer Behaviour • Given preferences and limited incomes, what amount and type of goods will be purchased? – What combination of goods will consumers buy to maximize their satisfaction?

Session 4: Consumer behavior and consumer preferences Consumer Preferences – Basic Assumptions • Preferences are complete – Consumers can rank market baskets • Preferences are transitive – If they prefer A to B, and B to C, they must prefer A to C • Consumers always prefer more of any good to less – More is better

Session 4: Consumer behavior and consumer preferences Consumer Preferences • Consumer preferences can be represented graphically using indifference curves • Indifference curves represent all combinations of market baskets that the person is indifferent to – A person will be equally satisfied with either choice

Session 4: Consumer behavior and consumer preferences Indifference Curves: An Example Market Basket Units of Food Units of Clothing A 20 30 B 10 50 D 40 20 E 30 40 G 10 20 H 10 40

Session 4: Consumer behavior and consumer preferences Indifference Curves: An Example • Graph the points with one good on the x-axis and one good on the y-axis • Plotting the points, we can make some immediate observations about preferences – More is better

Session 4: Consumer behavior and consumer preferences Indifference Curves: An Example Clothing 50 The consumer prefers A to all combinations in the yellow box, while all those in the pink box are preferred to A. B 40 H 30 E A 20 D G 10 10 20 30 40 Food

Session 4: Consumer behavior and consumer preferences Indifference Curves: An Example • Points such as B & D have more of one good but less of another compared to A – Need more information about consumer ranking • Consumer may decide they are indifferent between B, A and D – We can then connect those points with an indifference curve

Session 4: Consumer behavior and consumer preferences Indifference Curves: An Example Clothing 40 • Indifferent between points B, A, & D • E is preferred to points on U 1 • Points on U 1 are preferred to H&G B 50 H E 30 A 20 D 10 U 1 G 10 20 30 40 Food

Session 4: Consumer behavior and consumer preferences Indifference Curves • To describe preferences for all combinations of goods/services, we have a set of indifference curves – an indifference map – Each indifference curve in the map shows the market baskets among which the person is indifferent

Session 4: Consumer behavior and consumer preferences Indifference Map Market basket A is preferred to B. Market basket B is preferred to D. Clothing D B A U 3 U 2 U 1 Food

Session 4: Consumer behavior and consumer preferences Indifference Maps • Indifference maps give more information about shapes of indifference curves – Indifference curves cannot cross • Violates assumption that more is better – Why? What if we assume they can cross?

Session 4: Consumer behavior and consumer preferences Indifference Maps Clothing U 2 • B is preferred to D • A is indifferent to B & D • B must be indifferent to D but that can’t be if B is preferred to D U 1 A B D U 2 U 1 Food

Session 4: Consumer behavior and consumer preferences Indifference Curves • The shapes of indifference curves describe how a consumer is willing to substitute one good for another – A to B, give up 6 clothing to get 1 food – D to E, give up 2 clothing to get 1 food • The more clothing and less food a person has, the more clothing they will give up to get more food

Session 4: Consumer behavior and consumer preferences Indifference Curves A Clothing 16 Observation: The amount of clothing given up for 1 unit of food decreases from 6 to 1 14 12 -6 10 B 1 8 -4 6 D 1 -2 4 E 1 -1 2 3 4 G 1 5 Food

Session 4: Consumer behavior and consumer preferences Indifference Curves • We measure how a person trades one good for another using the marginal rate of substitution (MRS) – It quantifies the amount of one good a consumer will give up to obtain more of another good – It is measured by the slope of the indifference curve

Session 4: Consumer behavior and consumer preferences Marginal Rate of Substitution A Clothing 16 MRS = 6 14 12 -6 10 B 1 8 -4 6 D 1 -2 4 MRS = 2 E 1 -1 2 1 1 2 3 4 5 G Food

Session 4: Consumer behavior and consumer preferences References: § § Chapter 3 and 4 Microeconomics, R. S. Pyndick, D. L. Rubinfeld and Prem L. Mehta, Peason Publishing House. Consumer Behaviour: faculty. arts. ubc. ca/dqirjo/Teaching/PPLAM/ch 03_08_31_08. ppt