Theory Of Consumer Choice Flashcards
What are the assumptions of the standard economic model
Buyers are rational
More is preferred to less
Buyers seek to max utility
Consumers act in self interest and don’t consider utility of others
Standard economic model
Theory of consumer choice which examines how consumers facing these trade offs make decisions
What is the budget constraint?
Limit on the consumption bundles that a consumer can afford
What the consumer wants: what is the choice set
Set of alternatives available to the consumer
What the consumer wants: indifference curves
A curve that shows consumption bundles that give the consumer the same level of satisfaction
Indifference curves: the axiom of comparison
2 bundles of goods, A and B representing consumer choice
Consumer can compare bundles so that A is preferred to B
Or the consumer is indifferent between A and B
Indifference curves: the axiom of transitivity
3 bundles, A, B and C
If consumer prefers A to B, and B to C, then he must prefer A to C
If consumer is indifferent between A and B, and B an C, then he is between A and C
What are the 4 properties of indifference curves
1) higher indifference curves (further right the curve is ) are preferred to lower ones
2) indifference curves are downwards sloping
3) indifference curves do not cross
4) indifference curves are bowed inward
What is the marginal rate of substitution
The rate at which a consumer is willing to trade one good for another
MUx/MUy (MU=marginal utility)
What are perfect substitutes?
2 goods with straight line indifference curves
What are perfect compliments
2 goods with 90* curves
What is the consumers optimal choice
Consumers are constrained by resources available (shown by budget constraint)
- consumer chooses point on budget constraint that lies on highest indifference curve
What does the MRs equal at optimum
MRs=MUx/MUy
And at opt. MRs=Px/Py
So
MUx/MUy = Px/Py
What is the income effect
Change in consumption that results when a price change moves the consumer to a higher or lower indifference curve
Substitution effect
Change in consumption that results when a price change moves the consumer along a given indifference curve to a point with a new marginal rate of substitution
Deriving the demand curve: what is the price-consumption curve
A line showing the consumer optimum for 2 goods as the price of 1 changes, assuming incomes and the price of the good are held constant
What is the engel curve
Line showing relationship between demand and levels of income
What is a giffen good
Good where an increase in price raises the Qd
What is bounded rationality
The idea that humans make decisions under the constraints of limits and sometimes unreliable info
Why are people not rational
They are overconfident
Give too much weight to a small no. Of vivid observations
Reluctant to change their minds
Natural tendency to look for examples which consider their existing view
Use rule of thumb- heuristics
What are heuristics
Short cuts that people use in decision making
- anchoring (people start with something familiar)
- availability (decisions made based on assessment of risks of likelihood something happening)
- representativeness (judgements by comparing how representative it is to stereotype)
- persuasion(linked to various attributes that a consumer attaches to a product/brand)
- Simulation (people use mental processes to establish likely outcome)
What is expected utility theory
The idea that preferences can and will be ranked by buyers
