FAKULTAS REKAYASA INDUSTRI

PENGANTAR ILMU EKONOMI (IEI2C2)

by : BYG, FRD, SIN, RMK

Lecture Note #4
CONSUMER CHOICE
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Course Content
In this section, we examine four main topics:

1. Preferences
2. Utility
3. Budget Constraint
4. Constrained Consumer Choice

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Why?
 Supply – demand model can be used to answer questions about
market price of cars in Bandung, but can not answer questions
relating to individual behavior, why she or he buy specific car
 Are consumers better off receiving cash or a comparable amount in
food stamps?
 Should you buy insurance or save your money?
 Invest in bonds or in stocks?

 To answer these and other questions about how consumers allocate

their income over many goods, we use a model that lets us look at
an individual’s decision making when faced with limited income and
market-determined prices.  Model of individual behavior is
necessary
 This model allows us to derive the market demand curve that we used
in our supply-and-demand model and to make a variety of predictions
about consumers’ responses to changes in prices and income.(It is
used by Economist to predict behavior  demand curve)

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Consumer Behavior Model

The model of consumer behavior is based on the following premises :

 Individual tastes or preferences determine the amount of pleasure

people 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 constraints they face (such as budget, regulation)

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Consumer Behavior Model

In this section, we examine four main topics:

1. Preferences: We use five properties of preferences to predict which

combinations, or bundle, of goods an individual prefers to other
combinations.
2. Utility: Economists summarize a consumer’s preferences using a utility
function, which assigns a numerical value to each possible bundle of goods,
reflecting the consumer’s relative ranking of these bundles.
3. Budget Constraint: Prices, income, and government restrictions limit a
consumer’s ability to make purchases by determining the rate at which a
consumer can trade one good for another.
4. Constrained Consumer Choice: Consumers maximize their pleasure from
consuming various possible bundles of goods given their income, which
limits the amount of goods they can purchase.

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Preference
 To explain consumer behavior, economists assume that consumers have a
set of tastes or preferences that they use to guide them in choosing
between goods.
 Goods are ranked according to how much pleasure a consumer gets from
consuming each.
 Preference relations summarize a consumer’s ranking

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Preference
Property of Preference
 Completeness : when facing a choice between any two bundles of goods,
Bundles a and b, a consumer can rank them so that one and only one of
the following relationships is true: a b, b a, or both relationships hold so
that a and b is indifferent (a b)
 When facing a choice between two bundles of goods (e.g. a and b), a consumer
can rank them so that either a  b, b  a, or a ~ b.
 Transitivity: if the consumer weakly prefers a to b, a b, and weakly
prefers b to c, b c, then the consumer also weakly prefers a to c, a c.
 Consumers’ rankings are logically consistent in the sense that if a  b and b  c,
then a  c.
 More Is Better: more of a commodity is better than less of it.
 All else the same, more of a commodity is better than less.
 In this regard, a “good” is different than a “bad.”

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Preference Maps
Graphical interpretation of consumer preferences over two goods

Preference Map (Burritos & Pizza)

 Every semester Lisa decides how many pizzas and burritos to eat
 Various bundles shown in the figure
 At bundle e, Lisa consume 25 pizzas and 15 burritos
 More is better, so Lisa prefers all bundles that lie above and to the right
(area A) to Bundle e because they contain at least as much or more of
both pizzas and burritos as Bundle e.
 Curve I is an indifference curve: the set of all bundles of goods that a
consumer views as being equally desirable.
 Indifference curve I includes Bundles c, e, and a, so Lisa is indifferent
about consuming bundles c, e, and a.

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Preference Maps
Preference Map (Burritos & Pizza)
Figure 3.1 Bundles of Pizzas and Burritos Lisa Might Consume.
a) 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.
Consumer Choice
b) The indifference curve, I1, shows
a set of bundles (including c, e,
and a) among which she is
indifferent.
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c) The three indifference curves,
I1, I2, and I3, are part of Lisa’s
preference map, which
summarizes her preferences.
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Indifference Curves
The set of all bundles of goods that a consumer views as being equally
desirable can be traced out as an indifference curve.

Properties of Indifference Curve

 Bundles on indifference curves farther from the origin are preferred to
those on indifference curves closer to the origin (more is better)
 There is an indifference curve through every possible bundle.
 Indifference curves cannot cross.
 Indifference curves slope downward.
 Indifference curves cannot be thick.

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Indifference Curves
Impossible Indifference Curves.
Figure 3.2 Impossible Indifference Curves.
(a) Suppose that the indifference curves
cross at Bundle e. Lisa is indifferent
between e and a on indifference curve I 0
1
and between e and b on I If Lisa is
indifferent between e and a and she is
indifferent between e and b, she must be
indifferent between a and b by transitivity.
But b has more of both pizzas and burritos
than a, so she must prefer a to b. Because
of this contradiction, indifference curves
cannot cross.
Consumer Choice
(b) Suppose that indifference
curve I slopes upward. The
consumer is indifferent between b
and a because they lie on I but
prefers b to a by the more-is-
better assumption. Because of
this contradiction, indifference
curves cannot be upward sloping.
TEL U – FAK. REKAYASA INDUSTRI
(c) Suppose that indifference
curve I is thick enough to contain
both a and b. The consumer is
indifferent between a and b
because both are on I but prefers b
to a by the more-is-better
assumption because b lies above
and to the right of a. Because of
this contradiction, indifference
curves cannot be thick.
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Utility
 Underlying the model of consumer behavior is the belief that consumers can
compare various bundles of goods and decide which bundle gives them the
greatest pleasure.
 We can summarize a consumer’s preferences by assigning a numerical
value to each possible bundle to reflect the consumer’s relative ranking of
these bundles.
 Following the terminology of Jeremy Bentham, John Stuart Mill, and other
nineteenth century British utilitarianism economist-philosophers, economists
apply the term utility to this set of numerical values that reflect the relative
rankings of various bundles of goods.
 The statement that “Bonnie prefers Bundle x to Bundle y” is equivalent to the
statement that “Consuming Bundle x gives Bonnie more utility than
consuming Bundle y.” Bonnie prefers x to y if Bundle x gives Bonnie 10
utils—units of utility—and Bundle y gives her 8 utils.

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Utility
Utility Function
 is the relationship between utility measures and every possible bundle of
goods. If we know the utility function, we can summarize the information in
indifference maps succinctly.
 Suppose that the utility, U, that Lisa gets from pizzas and burritos is :

 Using this function, we can determine whether she would be happier if she
had Bundle x with 16 pizzas and 9 burritos or Bundle y with 13 of each.
 The utility she gets from x is : 12 utils. 

 The utility she gets from y is : 13 utils. 

 Therefore, she prefers y to x.

 Utility measure is ordinal scale  relative ranking of two things, but not how
much more one rank is than another.
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Utility
Utility and Indifference Curves
 In short, an indifference curve consists of all those bundles that correspond
to a particular utility measure. If Lisa’s utility function is U(q1, q2), then the
expression for one of her indifference curves is

 This expression determines all those bundles of q1 and q2 that give her Ū
utils of pleasure.

 for example, if the utility function is

 then the indifference curve 4 = includes any (q1, q2) bundles

such that q1q2 = 16, including the bundles (4, 4), (2, 8), (8, 2), (1, 16), and
(16, 1).

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Utility
Willingness to substitute between goods
 To analyze how consumers make choices when faced with limited
resources, it is useful to know the slope of an indifference curve at a
particular bundle of goods.
 Economists call the slope at a point of an indifference curve the Marginal
Rate of Substitution (MRS), because it is the maximum amount of one
good that a consumer will sacrifice (trade) to obtain one more unit of another
good.
 Lisa’s willingness to trade one good for another is measured by her
marginal rate of substitution (MRS): the maximum amount of one good a
consumer will sacrifice to obtain one more unit of another good.
 The marginal rate of substitution refers to the trade-off (rate of substitution)
of burritos for a marginal change in the number of pizzas.
 Lisa’s marginal rate of substitution of burritos for pizza is :

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Utility
Willingness to substitute between 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 = dq2 / dq1

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Utility
Marginal Utility and MRS
 The 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
Marginal utility o pizza = = U1 Marginal utility o burittos = = U2
∂q1 ∂q2

 Using calculus to calculate the MRS:

or

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Utility
Marginal Utility and MRS
 Moving from Bundle a to Bundle b, Lisa
will give up three burritos, to obtain one
more pizza, so her marginal rate of
substitution
 From a to b, ΔB = -3, ΔZ = 1
 MRS = -3/1 = -3
 The slope of the indifference curve is -3

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Utility
Curvature of Indifference Curves
 MRS (willingness to trade) diminishes along many typical indifference
curves that are concave to the origin.
 • Different utility functions generate different indifference curves:

Figure 3.4 Perfect Substitutes, Perfect Complements, Imperfect Substitutes

(a) Ben views Coke and Pepsi as
perfect substitutes. His indifference
curves are straight, parallel lines
with a marginal rate of substitution
(slope) of −1. Ben is willing to
exchange one can of Coke for one
can of Pepsi.
Consumer Choice
(b) Maureen likes pie à la mode but (c) Lisa views burritos and pizza
does not like pie or ice cream by as imperfect substitutes. Her
itself: She views ice cream and pie indifference curve lies between
as perfect complements. She will the extreme cases of perfect
not substitute between the two; she substitutes and perfect
consumes them only in equal complements.
quantities.
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Utility
Utility and Marginal Utility
 Marginal utility is the extra utility (ΔU) that
somebody gets from consuming the
additional unit of good (ΔZ)

 Lisa’s Case: Consumption of pizza increase

from Z = 4 to Z = 5, ΔZ = 1
 Utility increase from 230 to 250, so ΔU = 20

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Utility
The Law of Diminishing Marginal Utility
 The more of one good consumed in a given period, the less satisfaction
(utility) generated by consuming each additional (marginal) unit of the
same good

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Budget Constraint
 Consumer maximize their wellbeing subject to the constraints,
such as budget
 Lisa spend all the money Y on pizzas and burritos

 Example:
 If pZ = 1, pB = 2, Y = 50
 Rewrite the budget line equation for easier graphing
(y=mx+b form):

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Budget Constraint
 Allocation of $50 for burritos and pizzas, If price for pizza pZ = $1,
and burritos pB = $2
Bundle Burritos Pizzas
a 25 0
b 20 10
c 10 30
d 0 50

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Budget Constraint
 The bundles of goods that can be
bought if the entire budget is spent
on those goods at given prices

 Every extra unit Z that consumed

reduces B by –pZ/pB
 Slope of budget line is called
Marginal Rate of Transformation

or

 Marginal Rate of Transformation (MRT) is how the market allows consumers

to trade one good for another.

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Budget Constraint
 If the price of beer falls, holding the price of
wine, the budget, and tastes constant, the
typical American consumers buys more beer,
according to our estimates.
 (a) At the actual budget line, I1, where the
price of beer is $12 per unit and the price of
wine is $35 per unit, the average consumer’s
indifference curve, I1, is tangent at Bundle e1,
26.7 gallons of beer per year and 2.8 gallons
of wine per year. If the price of beer falls to $6
per unit, the new budget constraint is L2, and
the average consumer buy 44.5 gallons of
beer per year and 4.3 gallons of wine per
year.
 (b) by varying the price of beer, we trace out
the individual’s demand curve, D1. The beer
price-quantity combinations E1, E2, E3 on
demand curve for beer in panel b correspond
to optimal Bundles e1, e2, and e3 in panel a.

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Budget Constraint
Allocation of Fixed Expenditure Per Week Between Two Alternatives
(1) (2) (3) (4) (5)
TRIPS TO CLUB TOTAL MARGINAL PRICE MARGINAL UTILITY
PER WEEK UTILITY UTILITY (MU) (P) PER DOLLAR (MU/P)
1 12 12 $ 3.00 4.0
2 22 10 3.00 3.3
3 28 6 3.00 2.0
4 32 4 3.00 1.3
5 34 2 3.00 0.7
6 34 0 3.00 0

(1) (2) (3) (4) (5)

BASKETBALL GAMES TOTAL UTILITY (MU) (P) (MU/P)
PER WEEK
1 21 21 $ 6.00 3.5
2 33 12 6.00 2.0
3 42 9 6.00 1.5
4 48 6 6.00 1.0
5 51 3 6.00 .5
6 51 0 6.00 0

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Budget Constraint
 Utility-maximizing consumers spread out their expenditures until the following
condition holds:
MU X MU Y

PX PY
where:
MUX : marginal utility derived from the last unit of X consumed.
MUY : marginal utility derived from the last unit of Y consumed.
Y : quantity of Y purchased
PX : price of good X
PY : price of good Y

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Constrained Consumer Choice

 Consumers maximize their well-being (utility) subject to their budget constraint.
 The highest indifference curve attainable given the budget is the consumer’s
optimal bundle.
 When the optimal bundle occurs at a point of tangency between indifference
curve and budget line, this is called an interior solution.
 Mathematically,

 Rearranging, we can see that the marginal utility per dollar is equated across goods
at the optimum:

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Constrained Consumer Choice

 The interior solution that maximizes utility without going beyond the budget
constraint is Bundle e.
 The interior optimum is where

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Constrained Consumer Choice

 If the relative price of one good is too high and preferences are quasilinear, the
indifference curve will not be tangent to the budget line and the consumer’s
optimal bundle occurs at a corner solution.

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Problem 1
Jim spends most of his time in Jazzman’s, a coffee shop in south Bethlehem,
Pennsylvania. Jim has $12 a week to spend on coffee and muffins. Jazzman’s
sells muffins for $2 each and coffee for $1.20 per cup. He consumes qc cups of
coffee per week and qm muffins per week.
 Draw Jim’s budget line.
 Now Jazzman’s introduces a frequent-buyer card: For every five cups of coffee
purchased at the regular price of $1.20 per cup, Jim receives a free sixth cup.
Draw Jim’s new budget line.
 Does the introduction of the frequent-buyer card necessarily encourage Jim to
consume more coffee? Show how your answer depends on Jim’s preference
map.
 Use a budget line–indifference curve map analysis to explain which pricing
scheme Jim prefers

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References
Perloff, Jeffrey M., 2012, Microeconomics. 6th edition. Boston: Pearson
Case, Karl E., Fair, Ray C., Principles of Economics

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