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
Learning Objectives
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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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Learning Objectives (continued)
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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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Consumer Preferences
 Economists make three assumptions about
the typical consumer’s preferences:
1. Preferences are complete.
2. Preferences are transitive.
3. More of any good is preferred to less.
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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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Consumer Preferences Graphed as
Indifference Curves
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Indifference curve –
plots all the market
baskets that a
consumer views as
being equally
satisfactory
Figure 3.1
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Characteristics of Indifference
Curves
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Characteristics:
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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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Curvature of Indifference Curves
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Indifference curves are
convex to the origin.
Why?
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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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Individuals Have Different
Preferences
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[Figure 3.5]
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Graphing Economic Bads and
Economic Neuters
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[Figure 3.6]
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Perfect Substitutes and
Complements
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[Figure 3.7]
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The Budget Constraint
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[Figure 3.8]
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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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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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The Consumer’s Choice
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Marginal benefit
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Marginal cost
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The value the consumer derives from consuming one more
unit of a good
Measured by the MRSXY
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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A Corner Solution
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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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The Composite-Good Convention
[Figure 3.13]
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Changes in Income and
Consumption Choices
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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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Income-consumption Curve for an
Inferior Good
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The curve slopes
downward for normal
goods.
Figure 3.15
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The Food Stamp Program
[Figure 3.16]
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Are People Selfish?
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[Figure 3.18]
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The Utility Approach to Consumer
Choice
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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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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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