A Describe Consumer Choice Theory and Utility Theory

Question 1

Consumer Choice Theory

Answer 1

Relates consumer demand curves to consumer preferences. 1)Model preferences: what consumers would like to consume. 2) Model budget constraints: what consumers can consume with limited income
3. Combine preference theory and budget theory to arrive at the consumer choice theory demand curve

• It models tastes and preferences but does not say why consumers have tastes and preferences
• Consumer choice theory derives a demand curve as an implication of assumptions about preferences - economists are not trying to predict the behavior of any single consumer but of an aggregate market

Question 2

Utility Theory(an axiom of consumer choice theory which models preferences and tastes as rational actions that result in a more preferred consumption ‘bundle’ over a less preferred bundle.’)

Answer 2

Assumption of complete preferences: A consumer is able to make a comparison between any two possible bundes (Given A and B, consumer prefers A to B or is indifferent) “a consumer must be able to compare any two baskets of goods, either preferring one to the other or being indifferent between the two. “ - If a consumer finds two items so different that they cannot be compared then the consumer is violating the assumptions of complete preferences.

Assumption of transitive preferences: If A is preferred over B then A is preferred over C

Assumption of non-satiation: More is better

Question 3

Representing the Preference of a Consumer: The Utility Function (to translate each basket of goods and services into a number that rank orders the baskets according to our particular consumer’s preferences.)

Answer 3

First and foremost! Assume completeness, transitivity, non-satiation when asking a consumer to represent his own preferences in a consistent manner.

Restrictions: Comparing bundles: If the consumer prefers A to B he must rank A higher than B. If consumer is indifferent, consumer must rank A and B as the same number. “Simply order the bundles according to your preference over them”

The utility function of a particular consumer is a rule that translates the quantities of goods in each basket into the number that out consumer has assigned to each basket.

This number is called ‘utils’ or quantities of happiness

Question 4

Utility Functions important point

Answer 4

Utility function is just ordinal, rather, its just a ranking of bundles of goods.

*Remember, ordinal rankings do not allow the calculation and ranking of the differences between bundles.