Consumer Theory Flashcards
The theory of consumer choice relies on what three main premises
- Consumers have preferences that determine the satisfaction they get from the consumption of goods and services
- Consumer face constraints that limit their choice
- Consumers seek to maximize the level of satisfaction they obtain from consumption given the constraints that they face
So overall what do economists assume about consumers that guides them in choosing between goods
Consumers have a set of tastes or preferences - these can differ among individuals
The standard model of consumer behavior assumes preferences satisfy what three key conditions
- Completeness
- Transitivity
- More is Better (Non-satiation)
Describe the assumption of completeness in consumer theory
- Requires that for consumers facing choices between any two bundles of goods (A and B), then either
–> Consumer prefers A to B
–> Consumer prefers B to A
–> Consumer is indifferent between A and B - This ensures that the consumer can rank all possible bundles in terms of their desirability (so consumers must be able to decide on preferences for all possible options - no indecision)
Describe the assumption of Transitivity in consumer theory
- Requires that if a consumer prefers A to B, and prefers B to C, then they also prefer A to C
- this ensures that individuals are rational in their choices
Describe the assumption of More is better in consumer theory
- Requires that consumers always prefer more of a good to less
- referred to as non satiation
What does an indifference curve depict
The sets of bundles that a consumer views as being equally desirable
Indifference maps must satisfy what 4 properties
- Bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin
- An indifference curve goes through every possible bundle
- Indifference curves cannot cross
- Indifference curves slope downward
The slope of an indifference curve reflects what
How willing consumers are to trade one good for another (Marginal rate of substitution)
Define the marginal rate of substitution
The rate at which consumer is willing to substitute one good for another
If an indifference curve is convex what does that tell you
- convex means bowed towards the origin
- preferences exhibit a diminishing marginal rate of substitution
If an indifference curve is concave what does that tell you
- concave means bowed outward from the origin
- preferences exhibit an increasing marginal rate of substitution
Most people have what type of curvature for their indifference curve
- convex indifferent curves (therefore have diminishing marginal rate of substitution)
A constant marginal rate of substitution indicates what
- This means that goods are perfect substitutes
Describe perfect compliments
Goods that are always consumed in fixed proportions
Describe perfect substitutes
goods that are essentially equivalent from the consumers pov
Typically preferences lie between what two choices
between the two extremes of perfect substitutes and perfect compliments –> so goods are imperfect substitutes
What does the utility function describe
It describes the level of utility obtained from consuming goods and services
Do utility bundles exist in the real world
No, they are just an economical model of consumer behaviour
What type of measure is utility
an ordinal measure - helps you with relative ranking
Define marginal utility
This is the extra utility that a consumer gets from consuming an additional unit of a good (either x or y)
–> so it tells you how utility changes as we increase or decrease consumption of one good, holding the consumption of all other goods constant
What is the most important constraint that individuals face in the theory of consumer choice
the limitations imposed by their budget
The budget constraint/budget line represents what
all possible bundles of goods that can be purchased if the consumers entire budget is spent on those goods at given prices
What is the opportunity set
the set of all possible bundles of goods that a consumer can buy
Describe the Marginal rate of transformation
The trade off the market imposes on the consumer in terms of how much of one good the consumer must give up to purchase more of another good
So how do consumers maximize their well being, subject to the constraints that they face
Consumers pick the bundles of goods in their opportunity set that gives them the highest level of utility
What is an interior solution (in consumers reaching their optimal bundle)
This is where the optimal bundles has positive quantities of all goods and lies between the ends of the budget line
What is a corner solution (in consumers reaching their optimal bundles)
This is where the optimal bundle has a quantity of zero for at least one good, meaning the optimal bundle is at one end of the budget line
The optimal choice for a consumer lies where in relation to their budget line and their indifference curve
Where the indifference curve touches the budget line but does not cross it
Describe the effect of a buy two get one free promotion
- this creates a kink in the consumers budget constraint - if the new budget line crosses the pre promotion indifference curve then the promotion works
deviation: transitivity
- transitivity is where preferring A to B etc. so assuming they make rational choices
–> In Novel goods and Children this fails
deviations: endowment effect
standard model assumes that individuals value a good the same regardless of whether or not they own it. But evidence suggests that people place a higher value on a good if they own it than they do if they are considering buying it
deviations: salience
- model assumes that individuals consider all possible information when making a decision. Evidence suggests that people are more likely to consider information if it is presented in a way that grabs their attention, or takes little thought to understand
