Microeconomics 11^th Edition

Chapter 2

Consumer Tastes and Preferences

Consumer Preferences

Consumers have a preference when it comes to items. We will call them market baskets. If we have two market baskets a consumer will have a preference of one basket to another. If not they are said to be indifferent to them. We assume that all basket preferences are complete when they can choose one to another. We also assume that the choices are transitive. If A is preferred over B and B over C, one would assume that A is chosen over C as well. Our last assumption is that consumers will prefer more of a commodity over less. If the first basket has 10 of A and 1 of B and the second has 10 of A and 2 of B, then the consumer will choose B over A. We can increase A to make the consumer indifferent to the baskets though.

Determinates of Consumer Tastes and Preferences

Consumers taste can and sometimes do change. As a consumer experiences different things taste will change, for example, a child likes candy, as an adult he may like vegetables. Sometimes the demonstration affect will take hold. This is when people see something that someone else has and it influences their decision to purchase one, either positively or negatively. Advertising is also a influencer of consumers purchasing decisions. Lastly, choices are sometimes independent of price. This can lead to conspicuous consumption. While this can happen it is not always the case.

Indifference Curves

An indifference curve is a curve plotted in terms of alternative goods that could show up in a market basket. Given a group of baskets, a consumer should be able to tell you their preferences between them or even that they are indifferent between them. We take the ones that show indifference and then graph them. This shows the indifference curve. It is possible that a consumer could have several pairings that are grouped together and other pairs that would give a greater satisfaction. This would form an indifference curve that would be more appealing to the consumer. In creating these sets of curves we create an indifference map. Since indifference curves are designed that more of one product is preferred over another the characteristic of it will be a negative slope. The assumption that more is preferred over less will result in higher indifference curves. Lastly, if transitivity in preferences combined with more is better logic will make it impossible for two indifference curves will intersect each other.

The Concept of Utility

The concept of utility says that a consumer will be able to put a numeric preference to a market basket. Since a consumer prefers all items on an indifference curve the same, that curve will be assigned that number. Also it should be noted that a higher number means the consumer prefers that curve’s items over a lower number. As long as the numbers show a high to low preference, economists do not care about the numeric scale.

The Marginal Rate of Substitution

The marginal rate of substitution is the number of good Y that a consumer would be willing to give up to gain one unit of good X. The formula for this is (Y₂ – Y₁₎/(X₂ – X₁).

Deciphering the Shapes of Indifference Curves

A straight negative slope line shows a perfect substitution curve, one for one. A curve in the shape of an L would be Increasing X or Y from the corner without increasing the other is futile. Marginal rate of substitution here is 0 to the right of the corner and infinity at the corner. A curve in the line, like most indifference curves have, shows that the rate will decline along the curve. The decline will depend on the curve itself. The curve is assumed to be convex and the tangent of the curve lies beneath it.

The Budget Line

We assume that a consumer will try to maximize utility, that is, they will try to get on the highest possible indifference curve. No one has an infinite amount of money and can buy the basket that would be on the highest indifference curve so the choice has to be the best basket for what they can with their budget. To help understand, we assume that consumer can only buy two items and they must spend all their income (two statements that are not really true in the world). With these assumptions then:

QxPx + QyPy = I

Where Q is quantity, P is price, x and y are the items and I is income. This forms the budget line. The slope would be – Px/Py. Increases or decreases of income will not change the slope of the line only the amount of each item that can be purchased. If the cost of X increases, then the slope will change as we can now buy less of Y.

Equilibrium of the Consumer

Assuming that a consumer acts rationally, the market basket that would give the best utility and stay on the budget line would be the one that he would buy. To find this overlay the indifference curve and the budget line graph to find where the highest possible curve intersects the budget line.

Corner Solutions

In some case a consumer may choose to consume none of some good because they could not afford it. In this case the solution will be on the intersection of the Y line and be called a corner solution.

Corner Solutions and Diminishing Marginal Rates of Substitution

We have been working with the assumption of a concave curve. If the marginal rate of substitution rose in place of falling we would have a convex curve. If this happens it is possible for the budget line to have two intersections with two different indifference curves. This would lead to another corner solution as the intersection on the high curve end would normally be the intersection of Y. Since we do not see this type of purchasing (everyone only buys one product), then we can assume that this type of indifference curve is not normal.

Ordinal and Cardinal Utility

For what we are studying, ordinal utility, or putting items in a ranking order is sufficient. Economist used to believe that we should apply a preference based on cardinal numbers, or the difference between the numbers would show the weight of the preferences. If we can get a consumer to tell us their cardinal preferences, then this can be useful. We measure this in a unit called Util.

Marginal Utility

The total utility is the satisfaction level we just talked about. The marginal utility is the satisfaction that would be gained by one more unit of that commodity. Again we assume for simplicity, two items. We construct a table to show the utility at various quantities:

Number of X	Total Utility of all	Marginal Utility
0	0	-
1	4	4 (4 – 0)
2	9	5 (9 – 4)
3	13	4 (13 – 9)
4	16	3 (16 -3)
5	18	2 (18 – 16)

We see that we get increased satisfaction till it gets to 2 units of X and then, though the total utility goes up, we get less and less satisfaction for each unit added. This leads to the law of diminishing marginal utility that states that the more a consumer consumes of a quantity the marginal utility will eventually start to decline.

Budget Allocation Rule

A consumer will try to maximize his utility so that the marginal utility of the item will be in proportion to its price. The formula is roughly stated as follows:

(MUx)/Px = (MUy)/Py

This roughly translates down to the last unit that a person will want to buy will give him an util that will be equal to the util received from the other product. This will maximize his satisfaction with that market basket.

Ordinal Utility Revisited

While the above principle should be understood, in general, consumers do not give preference with cardinal numbers and it can limit its use. Our formula from above can be rewritten:

MUx/MUy = Px/Py

Our formula for ordinal marginal rate of substitution is:

MRSxy = MUx/MUy

From these formulas we can derive:

MRSxy = Px/Py

So basically we should find the customer equilibrium point the same with we use cardinal or ordinal numbers.

Revealed Preference

We assume in all this statements that the consumer is telling the truth in all he is providing us information for. We cannot know that for sure unless we experiment with his budget line (both the income and the prices) and see where his preferences would really lie. This shows us his revealed preferences.