Consumer Behavior

To understand consumer behavior: 

• The first step is to examine the consumer preferences (we need practical means of describing how consumer might prefer one good to another).
• Account for the fact that the consumer face the budget constraints because they have limited income to allocate among consumption items.
  
  Px X +Py Y= I
• To put consumer preferences and budget constraints together to determine consumer choices. 

Consumer preferences.

Concept of market basket (just the collection of one or more commodities) For e.g. it can contain a various food items in a bag of groceries or the combination of food clothing and fur that the consumer buys each day, month etc.

Some basic assumptions.

• Preferences are complete, which means that a consumer can rank all market baskets. E.g. For any two market baskets A and B, the consumer can prefer A to B or B to A, or can be indifferent.
• Preferences are transitive. It means, that if a consumer prefers basket A to B and prefers B to C, then he should also prefer A to C.
• Preferences are reflexive (desirable). So that leaving costs aside, consumer always prefer more of any good to less. ( this applies to economical goods, and not applies to bad goods such as pollution)

Indifference curves - graphical presentations of consumer preferences.

An indifference curve represents all combinations of market baskets that provide the same level of satisfaction or utility to a person or consumer.

This curve indicates that the consumer is indifferent between that three market baskets (A, B, C) It tells us that the consumer feels neither better of nor worse off for giving up 10 units of food to obtain 20 units of clothing in moving from basket A to B.

Thus persons indifference curve U1 shows all market baskets that generate the same level of satisfaction, as does market basket A.

Indifference map.

It is a set of indifference curves that describes the person's preferences. A set of indifference curves represents an ordinal ranking. An ordinal ranking arrays market baskets in a certain order, such as most preferred, second most preferred… third most preferred, etc.

Market basket A is in the highest of three indifference curves. It preferred to B and C, B preferred to C.
The assumptions made about the consumer preferences for economic goods imply that indifference maps have the followings:

• Market baskets on indifference curves further from the origin are preferred.
• Indifference curves cannot intercept. If the market basket represented by point A is on both indifference curves U1 and U2 where U1>U2 this implies that the consumer is indifferent between B and C. So A< C & A< B. But market basket B has less of both goods (Food and clothing) than C has. It must therefore follow that he prefer C to B. This is a contradiction because the consumer cannot simultaneously prefer one basket to another

Marginal rate of substitution (MRS). MRSxy -rate of substitution of X for Y. It is the amount of good Y that the consumer would give up to obtain one more unit of good X while holding utility constant. The slope of an indifference curve measures the consumer MRS between two goods.

MRSxy = -DQy / DQx = -DC / DF

MRSxy = -6/1=-6

-DC / DF falls from 6 to 4 to 2.
When MRS diminishes (declines) along the indifference curve preferences are convex.

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