Consumer Choice
Learning Objectives:
• Understanding consumer opportunity and consumer preference
• How do changes in price and income influence consumer choice?
• How do workers decide how long to work?
Ordering of Consumer Preference
• Preferred choice vs. Indifferent choice
• Basic Properties:
•
•
•
•
Completeness
More is better
Diminishing marginal rate of substitution
Transitivity
Indifference Curve
• An indifference curve provides all the combinations of a set of goods
giving a consumer the same level of satisfaction.
• Utility Function: U = 𝑈(𝑋, 𝑌)
• Marginal Rate of Substitution
Budget Constraint
• A budget constraint gives the total amount of money a consumer can
spend on a set of goods.
• Budget line: M = 𝑃𝑋 𝑋 + 𝑃𝑌 𝑌
• Market rate of substitution
• Movements in the budget line due to changes in income and prices
• Example: Advertisement
Consumer Equilibrium
• Marginal rate of substitution will be equal to market rate of
substitution
• In equilibrium: −
𝜕𝑈
𝜕𝑋
𝜕𝑈
𝜕𝑌
=
𝑑𝑌
𝑑𝑋 𝑈=𝑈
=
𝑃𝑋
𝑃𝑌
Comparative Statics
• Change in optimal consumption due to price and income changes
• Substitutes vs Complements
• Example: Want people to drink less? Make their cigarettes more
expensive
• Example: Cheap gas makes suburban houses more valuable
• Example: What Happens to Broadway Shows After Movie Versions Hit
Screens?
Comparative Statics (contd.)
• Income effect and substitution effect
• Normal Good versus Inferior Good
• Kinked choice set
• Example: Optimal product mix in a supermarket
Labor Leisure Choice
• How do workers decide how long to work?
• The economics of overtime
Individual Demand Curve
• From indifference curve to individual demand curve
• From individual demand curves to market demand curve