Chapter 3: Consumer Constrained Choice

Consumer behavior model

Individual tastes or preferences determine the amount of pleasure ppl derive from
the goods and services they consume.
Consumers face constraints, or limits, on their choices.
Consumers maximize their well-being or pleasure from consumption subject to the
budget and other constraints they face.
- Consumers buy the goods that give them the most pleasure, subject to the
constraint that they spend more money than they have nor can they spend it in ways
forbidden by the government. Eg drugs & alcohol are restricted for young ppl
3.1Preference
Preference: using 5 different properties of preferences to predict which combinations, or bundle,
of goods an individual prefers to other combinations.
- Economist assumes that consumers have a set of preferences or tastes that they
use to guide them in choosing between goods.
a b consumers prefer Bundle a at least as much as bundle b
- But the consumer does not weakly prefers b to a, then we say that
consumer strictly prefers a to b.
3 Assumptions of Consumer Preference Properties
1. Completeness
a. When facing a choice between two bundles of goods (eg. a and b),
a consumer can rank them so that either a b , b a , or a b .
b. This properties rules out the possibility that the consumer cannot
decide which bundle is preferable.
2. Transitivity
a. This property eliminates any possible illogical behaviors.
b. Consumers rankings are logically consistent in the sense that if
a b and b c and then a c
c. The transitivity property eliminates the possibility of certain types
of illogical behavior
*If completeness and transitivity hold, the preference relation is said to be rational.
3. More is better.
a. All else the same, more of a commodity is better than less,
Indifference Curve: The set of all bundles of goods that a consumer views as being equally
desirable can be traced out as an indifference curve.
5 important properties of an indifference curve
1. Bundles on indifference curves farther from the origin are preferred to those on
indifference curves closer to the origin.
2. Every bundle lies on an indifference curve.
3. Indifference curves cannot cross.

4. Indifference curves cannot be be thick.

5. Indifference curve slopes downwards
Why economist assume more-is-better?
- It appears to be true for most people
- If consumers can freely dispose of excess goods, consumers can be no worse off
with extra goods.
[Fig. 3.1] Lisa prefers more to less, so she prefers Bundle e to any bundle in area B, including d.
Similarly, she prefers any bundle in area A, Such as f to e. (be c, e, and, a) among which she is
indifferent. (c) The three indifference curves, I 1 I 2 I 3 are part of Lisas preference map, which
summarizes her preferences.

[Fig. b] Lisa prefers e to b because bundle b lies below and to the left of Bundle a. Both Bundles
a and e are on indifference curve I 1 , so Lisa likes Bundle e as much as Bundle a.
3.2 Utility
Utility: refers to a set of numerical values that reflect the relative rankings of various bundles of
goods.
Utility function: is the relationship between utility measures and every possible bundle of
goods.
Given a specific utility function, you can graph a specific indifference curve and
determine exactly how much utility is gained from specific consumption choices.
q 2= burritos
Eg. q1 = pizza
U=q10.5 q10.5 =
Bundle x contains 16 pizzas and 9 burritos: U(x) = 12
Bundle y contains 13 pizzas and 13 burritos: U(y) = 13
Thus, y x
- Consumers can easily answer questions about whether they prefer one bundle to
another.
- However, they will have difficulty answering questions about how much they
prefer one bundle to another because they do not have a measure to describe how their
utility differs from two bundles differ.
- Therefore, we may know a consumers rank ordering bundles, we are unlikely to
know by how much more that consumer prefers one bundle to another.

- Utility is an ordinal measure rather than a cardinal one.

Ordinal: a measure that tells us the relative ranking of two things but not tell us how much more
one rank is valued than another.
Utility Summary
- Utility tells us the relative ranking of two things but not how much more one rank
is valued than another.
- We dont really care that U(x)= 12
- And U(y)= 13 in the previous example; we care that y x
- Any utility function can be transformed into another utility function in such a way
that
preferences are maintained.
- Positive monotonic transformation.
Willingness to Substitute Between Goods
- How willing a consumer is to trade one good for another depends on the slope of
the consumers indifference curve at the consumers initial bundle of goods.
Marginal Rate of Substitution (MRS): is the maximum amount of one good that a consumer
will sacrifice (trade) to obtain one more unit of another good.
It is the slope at a particular point on the indifference curve.
MRS depends on how much extra utility a consumer gets from a little more of
each good.
Marginal Utility: is the extra utility that a consumer gets from consuming the last
unit of a good, holding the consumption of other goods constant.
U
=U 1
Marginal utility of pizza =
q1
U
Marginal utility of burritos = q =U 2
2
a q 2
=
MRS =
1a q 1

Intuition: As we move down and to the

right along the indifference curve, we

increase the amount of q1 slightly, which

increase U1 so we must decrease the
consumption of q2 to hold U constant

Diminishing MRS
MRS (willingness to trade) diminishes along many typical indifference curves
that are concave to the origin.
As we move down to the right along this indifference curve, the slope (MRS)
becomes smaller in absolute value.

Curvature of Indifference Curves

Different Utility functions generate different indifference curves:

1. Perfect Substitutes
a. Goods that consumer is completely indifferent between
b. Eg. Pepsi and Coca-cola (same)
c. Eg. Clorox (C) and Generic Bleach (G)
U(C,G) = iC + jG
MRS = -2 (constant straight line)
2. Perfect Complements
a. Good that are consumed in fixed proportions.
b. Example: Marie only eats apple pie with ice scream. She will not
consume them individually.
c. MRS is undefined b/c she only consumes a, b, and c where pie and
ice cream are in equal proportions.
d. MRS = 0/undefined b/c she is unwilling to substitute more of one
good for less of another.
Budget Constraint
Knowing an individuals preference is only the first step in analysing that persons
consumption behavior.
The most important constraint is deciding what to consume given our personal
budget.
This constraint shows which combinations of goods are affordable.
It is from among these combinations that a person can choose the
bundle that provides the most utility.
Start by showing the budget constraint: this shows the limit that income places on
the combinations of goods that can be bought.

 Consumers maximize utility subject to constraints.

If we assume consumers cant save and borrow, current period income determines
a consumers budget.
P
Given price of Pizza ( 1) and burritos ( P2 , and income Y, the budget

line is
Y= p1 q 1 + p 2 q 2
Rewrite the last equation:
q 2=

P
Y
( 1 )q 1
P2
P2

If all income spent on q 2, Y /P will be purchase, and if all income is spent on

q1 Y / P1 will be purchase
The slope of budget line P1 / P2 represents opportunity cost of q1 in terms
of foregone q 2.
Eg. assume p1=$ 1, p2 =$ 2Y =$ 50
Rewrite the budget line equation for easier graphing (y = mx+b form)
$ 50($ 1 q 1)
1
=25 q1
$2
2
Marginal Rate of Transformation (MRT): is how the market allows consumers to trade one good
for another.

 It is the slope of the budget line: MRT=

d q 2 p1
=
d q1
p2

3.4 Constrained Consumer Choice

Consumers maximize their well-being (utility) subject to their budget constraint.
The highest indifference curve attainable given the budget is the consumers
optimal bundle.
When the optimal bundle occurs at a point of tendency between the indifference
curve and budget line, this is called an interior solution.
U 1 p 1
MRS = - U = p =MRT
2
2
Rearranging, we can see that the marginal utility per dollar is equated across
U 1 U2

goods at the optimum:

p1
p2
Utility Maximization: A graphical View
We have the budget constraint. Not we want to add on an indifference curve.

 So at point C, you are maximizing utility

1. You are on the budget constraint: all income is spent.
2. The indifference curve is tangent to the budget constraint: MRS = price ratio.
Constrained Consumer Choice
The interior solution that maximizes utility without going beyond the budget
constraint is Bundle e.
U 1 p1
=
The interior optimum is where MRS = =MRT
U 2 p2

Constrained Consumer Choice with Perfect Compliments

The optimal bundle is on the budget line and at the right angle (i.e. vertex) of an
indifference curve.