o Consumer Preferences o Budget Constraints o Consumer Choice o Others

Week 2

Chapter 3: Consumer Behavior

Microeconomics 1 – I (Rasi Lucentezza)

TA:
Sendy Jasmine Karunia Hadi
E-mail: sendy.jasmine@ui.ac.id

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Outline
• Consumer Preferences
• Assumptions
• IC & MRS Concept
• Budget Constraints
• Consumer Choice
• Others
• Revealed Preference
• Rationing
• Price Index
• Homework Discussion
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Consumer Preferences

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Assumptions on Individual Preferences

• 3 basic assumptions about individual preferences:
1. Completeness: A ≻ B or B ≻ A.
2. Transitivity: if A ≻ B and B ≻ C, then A ≻ C.
3. More is better than less: all goods are desirable; consumer will always
prefer more of a good.
• Additional assumption*: Convexity à diminishing MRS; IC curve increases
(becomes less negative) as we move down along the curve.

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Indifference Curve (IC)

• A curve that represents all combination of market baskets that
provide a consumer with the same level of satisfaction.
*Indifference map: a set of
indifference curves that
describe a person’s
preferences

Downward, convex,
diminishing MRS

Source: economics.utoronto.ca.
Source: Pindyck & Rubinfeld (2017)

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(cont.)
• So, does IC curve can only be downward sloping?
• Well, technically no it doesn’t, because sometimes, it depends on:
1. Preferences

hamburger hamburger hamburger

soft drink soft drink

soft drink
(a) (b) (c)

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(cont.)
• Explanation:
a) A has convex preferences and dislikes both hamburger and soft drink.
b) B likes hamburgers, but neither likes nor dislikes soft drinks.
c) C loves hamburgers and dislikes soft drinks. If he is served a soft drink, he will drink it to be
polite.

2. Type of Goods
hamburger hamburger

Explanation: Explanation:
d). D loves hamburgers and soft e). E always gets twice as much
drinks, but insists on consuming satisfaction from an extra
exactly one soft drink for every two hamburger as she does from an
hamburgers that she eats. extra soft drink.

soft drink
(d) soft drink (e)

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(cont.)
• BUT one thing you should always remember: ICs can’t intersect!
Good Y

Violates the assumption:

more is better than less.
A

C
U2

B
U1
Good X

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o Consumer Preferences o Budget Constraints o Consumer Choice o Others

Ordinal vs Cardinal Utility

• Ordinal à order à ranking of market baskets from the most to least
preferred.
• It does NOT, however, show the magnitude of each rank (i.e., how much
bundle A is much more preferred than bundle B, etc).
• Example: if I have 3 books and you have 5 books, does it mean that you are
5x times happier (or more satisfied) than me?
• Cardinal à describing how much one basket is more preferred than
the others.
• It’s still impossible to know exactly how can we get the measurement for
this.
• We will only deal with ordinal utility in microeconomics.

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Marginal Rate of Substitution (MRS)

• The rate at which the consumer is willing to trade one good for
another to maintain the same level of satisfaction. à slope of IC

∆"
MRS = - ∆#
OR
∆$
MRS = - ∆%

Source: Pindyck & Rubinfeld (2017)

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o Consumer Preferences o Budget Constraints o Consumer Choice o Others

(cont.)
• MRS in utility function:
𝑈 𝐹, 𝐶 = 𝐹 + 𝐶

Then, MRSF,C can be obtained from total derivative of utility function:

𝜕𝑈 𝜕𝑈
𝑑𝑈 = 𝑑𝐹 + 𝑑𝐶 = 0
𝜕𝐹 𝜕𝐶
*MU measures the additional
𝜕𝑈
𝑑𝐶 − 𝜕𝐹 − 𝑀𝑈𝐹 satisfaction obtained from
= +𝜕𝑈 = consuming one additional
𝑑𝐹 𝑀𝑈𝑐 unit of a good
𝜕𝐶

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(cont.)
• MRS for substitution goods = 1.
• MRS for complementary goods = 0 or ∞.
hamburger
hamburger

soft drink soft drink

Substitution goods Complementary goods

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Budget Constraint

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Budget Line (BL)

• All combinations of goods for which the total amount of money
spent is equal to income.
• BL equation: PFF + PCC = I
Slope BL = -PF/PC I = PFF + PCC
C = I – PFF/Pc
OR Then, we can get the
slope of the C equation:
Slope BL = -Px/Py -PF/PC
Source: Pindyck & Rubinfeld (2017)

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Changes in Budget Line (BL)

(1) (2)

Changes in income will shift Changes in the price of the

the BL. good will rotate the BL.

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Consumer Choice

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When will consumer’s utility get maximized?

• When Slope of IC (MRS) = Slope of BL (Price Ratio)
• Why? Because at that time, IC and BL will be at tangency, meaning that
their trade-offs are equal and consumer satisfaction is maximized.
• MRS = marginal benefit // Price ration = marginal cost.

Source: Pindyck & Rubinfeld (2017)

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Corner Solution
• When a consumer buys in
extreme.
• In this case MRS ≠ Price
ratio, rather, MRS ≥ Price
ratio.

Source: Pindyck & Rubinfeld (2017)

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Others*

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Revealed Preference
• Previously, we tried to
acknowledge consumer
choice; now, can we
determine her preferences?
• RP tells you about consumer
preferences given her chosen
market basket(s).
• It aims to “check” the
consistency of the assumption
in consumer theory about
individual choices.
Source: Pindyck & Rubinfeld (2017)

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Rationing
• Nonprice rationing is an alternative that some consider more equitable
than relying on uncontested market forces. Under a market system,
those with higher incomes can outbid those with lower incomes to obtain
goods that are in scarce supply.

Under the case of

rationing, is the
consumer always
worse-off? à it
depends on the
competitive
market price
without rationing.

Source: Pindyck & Rubinfeld (2017)

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Price Index

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Homework 2 - Discussion

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