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Managerial Economics: Consumer Choice

Consumer choice is used to derive demand curves in any given market
Standard Economic Model of Consumer Behavior:
- Individual tastes and preferences
- Consumer constraints (budget or income)
- Consumer satisfaction
Consumers spend on bundles of products that bring them the most satisfaction
Consumer sovereignty: consumer is the boss
...


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Prefer A over B
And prefer B over C
Then A is also
preferred over C

Rules that indifference (liking
two bundles of goods equally)
is possible but indecision is
Transitivity is necessary for
not
rational decision making

All other factors constant
more of a good is better than
less
There is no point of
satiation Ex: you can’t ever
have too much money
...


Preference Maps: graphical representation of consumer preferences
- Allows for us to handle preferences algebraically and solve for them as such
- Start with the “more is better” property and construct the map from that point

Indifference Curve: the set of all bundles of goods that a consumer views as equally desirable
- Each line shows a combo of goods with the same utility as viewed by the consumer
All indifference curves must have/ rules:
- Bundles on indifference curve farther from origin are preferred versus those that are
closer to the origin (higher)
- Indifference curves must go through every possible bundle
- Indifference curves cannot cross
- Indifference curves slope downwards (MRS = slope of indifference curve)
If the curve is convex it is bowed in towards the origin
- Most indifference curves are convex
Extreme Indifference Curves:
Straight Line

Right Angle

Perfect Substitutes

Perfect Complements

Marginal Rate of Substitution: shows that trade offs and substitutions can be made and is the
rate at which this is measured = rate at which a consumer can substitute one unit of a good for
one unit of another good while remaining on the same indifference curve
Diminishing Marginal Rate of Substitution: willingness to trade more of one good for less of
another good
Utility: how consumers rank the different bundles - how they rank what they get out of those
bundles or in other words satisfaction they derive from a given bundle
- Utility Function: relationship between utility and every possible # of bundles
- Ordinal Utility: info only on the rankings or ‘ordering’ of bundles
- Cardinal Utility: Absolute numerical comparison
- Ex: weight
- Marginal Utility: extra utility derived from consuming 1 more unit of a good

The Budget Constraint: often the most important constraint among consumers
- Consumers maximize their utility subject to their respective constraints
Terms budget and income can be used interchangeably
Budget Line: maximum amount of what can be bought within the constraints of the budget
Opportunity Set: all bundles inside the budget line
Marginal Rate of Transformation = slope of the budget line
- Trade off the market imposes on consumers
- Amount of 1 good that must be given up to purchase more of other good
Optimal Bundle: Bundle that can be afforded within the budget constraint that provides the
most amount of pleasure or ‘utility’
- Point on the highest indifference curve that touches the budget line
- There is no incentive to change or substitute with the optimal bundle
Corner Solution: when the consumer only buys one of two goods - only purchases the most
preferred good rather than bundle of goods
Endowment Effe

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