Consumer Behavior A Flashcards
A rational consumer purchases the goods and services which they
- “like best”;
- “can afford”.
What does “like best” mean?
The concept of preferences
What does “can afford” mean?
The concept of budget constraint
Assumption consumer behaviour
Consumers have preferences over consumption bundles
a consumption bundle
- is a set of quantities of different goods or services
- consists of several goods
- can be preferred to another consumption bundle
Strict preference
Consumption bundle A is strictly preferred to B, i.e. A ≻ B.
Weak preference
Consumption bundle A is weakly preferred to B, i.e. A ≿ B.
Indifference
The consumer is indifferent between the two consumption bundles, i.e.
A ∽ B ⇔ A ≿ B and B ≿ A.
ASSUMPTIONS ABOUT CONSUMER PREFERENCES
Completeness
Non-satiation (also: monotonicity)
Transitivity
Completeness
for all consumption bundles it holds that A ≿ B or B ≿ A or both (for indifference).
* Intuition: a consumer can compare any two consumption bundles.
Non-satiation (also: monotonicity)
Definition: for the consumption bundles A and B it holds that: if A ≥ B, then A ≿ B; if A > B, then A ≻ B.
* Intuition: if bundle A contains at least as much of each good as (strictly more than) bundle B, it is weakly (strictly) preferred to B.
Transitivity
- Definition: for three consumption bundles A, B, C it holds that: if A ≿ B and B ≿ C, it must also hold that A ≿ C.
- Intuition: a consumer decides consistently.
An indifference curve
shows the set of all consumption bundles among which the consumer is indifferent.
All the consumption bundles “above” an indifference curve are
preferred to the consumption bundles on the indifference curve
Indifference curves cannot..
cross (because of the Transivity assumption)
INDIFFERENCE CURVES FOR PERFECT SUBSTITUTES
INDIFFERENCE CURVES FOR PERFECT COMPLEMENTS
INDIFFERENCE CURVES FOR A NEUTRAL GOOD
INDIFFERENCE CURVES FOR A “BAD”
Preferences are (strictly) convex if …
the slope of the indifference curves decreases along the curve.
Intuition
consumer prefer variety; the more they have of a particular good, the more units they are willing to give up of that good to get additional units of another good.
A utility function
assigns a utility (a numerical value) to each consumption bundle. Higher utilities are assigned to preferred consumption bundles.
The utility function describes only the ranking of the consumption bundles, i.e. utility is an ordinal concept:
– no cardinal interpretation possible (how much better is A?).
– any transformation that preserves the ranking (“monotonic
transformation”) is possible (see below).
– the absolute utilities have no interpretation.
– interpersonal utility comparisons are not possible.
Linear:U(X,Y)=aX+bY,with a,b>0.
– The indifference curves are downward sloping straight lines.
– Perfect substitutes
Minimum: U(X, Y) = min{aX, bY}, with a, b > 0.
– The utility depends on the quantity of only one of the goods.
– Indifference curves are L-shaped (“Leontief”).
– Perfect complements.
Cobb-Douglas: U(X, Y) = XαY1−α, with 0 < α < 1
– is particularly appropriate for simple calculations.
– Indifference curves are strictly convex.
CES: U(X, Y) = (Xρ + Yρ)1/ρ
– particularly flexible.
– Indifference curves: straight lines (ρ = 1), convex (ρ → 0) or
L-shaped (ρ → −∞).
A monotonic transformation of a utility function is…
a utility function that represents the same preferences as the original utility function
–> transforme l’ecriture sans changer l’orde (toujours que le panier preféré de la fonction soit dans le meme orde)
represent a monotonic transformation by a function
f(U), with f′(U) > 0, that transforms each utility level U into some other utility level f(U), such that U(A) > U(B) also implies f(U(A)) > f(U(B)).
A transformation which changes the form of the indifference curves cannot…
be monotonic.
marginal rate of substitution (MRS)
the slope of the indifference curve
Find the marginal utility of each good
ΔU is the change in utility (the additional satisfaction)
/ΔQ is the change in quantity consumed (typically 1 unit)
cobb douglas function with x^ a 1 x^b
a + b = 1
