Micro3 - Chapter 3 Consumer Behavior Consumer Preferences...

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Chapter 3 Consumer Behavior Consumer Preferences Consumer theory deals with how individuals allocate their limited income among their needs and wants. Naturally, we can not satisfy all our wants. Therefore, we have to make choices. Consumer theory makes several assumptions on consumer behavior and based those assumptions explains how individuals spend their income. The three main assumptions are: 1- Completeness Assumption: Every consumer knows his or her own taste and based on that can rank different basket of goods. Given two basket of goods A and B, consumer either prefers A to B, or prefers B to A, or is indifferent between A and B. 2- Preferences are Transitive. If A is preferred to B and B is preferred to C, then A is preferred to C.
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Chapter 3 Consumer Behavior 3- More is Preferred to Less: Goods are assumed to be desirable. We all like to have more of “good” things. Offered for free or for the same price, we naturally choose a basket of goods that contains more over the basket that contains less of the same goods. Indifference Curves All combinations of different basket of goods that provides consumer with the same level of satisfaction. Given different basket of goods below and an initial basket of A, it is clear that consumer will prefer any basket in the orange area to a basket in the green area. However, the remaining baskets (E, F, G, H) can not clearly be compared to A without additional information.
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Chapter 3 Consumer Behavior All the baskets in the orange area are preferred to the baskets in the green area. When it comes to the points in the white area (E, F, G, H), a consumer may prefer them to A, not prefer them to A, or my be indifferent. Ranking Basket of Goods
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Chapter 3 Consumer Behavior A line connecting all the points that gives the consumer the same level of satisfaction is called indifference curve.
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Chapter 3 Consumer Behavior Indifference Map: A set of indifference curves each showing combination of basket of goods that consumer is indifferent. Consumer receives higher level of satisfaction from I3 than I2 or I1.
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Chapter 3 Consumer Behavior Properties of Indifference Curves: 1- Indifference curves can’t cross each other. Crossing indifference curves violates the transitivity assumption. A = B, and A = C. Therefore, by transitivity rule B = C. However, C > B.
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Chapter 3 Consumer Behavior 2- Indifference curves are convex. This implies that in trading one good for the other, each time consumer is willing to give up smaller amounts of one good for the same amount of the other good. This trade-off is presented by the slope of the indifference curve and is called Marginal Rate of Substitution (MRS).
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Chapter 3 Consumer Behavior Extreme Cases: Perfect Substitute & Perfect Complement
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This note was uploaded on 07/07/2008 for the course ECON 100B taught by Professor Bacolod during the Summer '05 term at UC Irvine.

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Micro3 - Chapter 3 Consumer Behavior Consumer Preferences...

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