Lecture – 4

Dr Soumyatanu Mukherjee
Decision Making in the Household
Consumer Choice
Households would spend all
their money on
commodities.

How does a
consumer/household The more commodities a
decide to spend their Assumptions: household consumes
money on different the more the satisfaction.
commodities?
Transitive preferences: If a
household prefers a
bundle A to B, and a bundle
B to C, the household must
prefer the bundle A to C.
 Exercise To Solve
The Bear family is trying to decide what to have for dinner.

• Baby Bear says that his ranking of the possibilities is (honey, grubs, Goldilocks).

• Mama Bear ranks the choices (grubs, Goldilocks, honey).

• Papa Bear’s ranking is (Goldilocks, honey, grubs).

They decide to take each pair of alternatives and let a majority vote determine the family rankings.
(a) Papa suggests that they first consider honey vs. grubs, and then the winner of that contest vs.
Goldilocks. Which alternative will be chosen?
(b) Mama suggests instead that they consider honey vs. Goldilocks and then the winner vs. grubs. Which
gets chosen?
(c) What order should Baby Bear suggest if he wants to get his favourite food for dinner?
(d) Are the Bear family’s “collective preferences,” as determined by voting, transitive?
Total and Marginal Utility—1
Total utility:
• The overall amount of happiness from consumption
Marginal utility:
• Additional utility gained from consuming one more unit of a
good or service
Diminishing marginal utility:
• Occurs when marginal utility declines as consumption
increases
Example: The Table Below Gives Scores Generated
by a Utility Function
The locus of commodity bundles with the
same score when plotted on a graph gives an
indifference curve. Draw the indifference
curve of commodity bundles having a score
of 1000.

Marginal utility of x (MUx) is the increase in

utility when consumption of x increases by
one unit.
Total and Marginal Utility—2

Fun Fact: How could you tell

whether the marginal utility
someone derived from a TV show
had not just gone down to zero but
gone negative?
Economic Goods and Bads

Suppose you have unlimited income. How much pizza

and Pepsi would you buy?
Economic “goods”:
• Consuming more leads to higher total utility.
• Marginal utility is positive.
Economics “bads”:
• Consuming more leads to lower total utility.
• Marginal utility is negative.
Indifference Curves
Properties of Indifference Curves—1

Indifference curves are usually bowed inward:

• Quadrant I of previous figure
• Based on assumption that averages are preferred to
extremes
The slope of the indifference curve is the marginal rate of
substitution (MRS):
• The rate at which a consumer is willing to purchase one
good instead of another
A Typical Indifference Curve

4, 3
Properties of Indifference Curves—2
Indifference curves cannot be “thick.”
• This would violate “more is preferred to less.”
Indifference Curves Cannot Be Thick
Properties of Indifference Curves—3

Indifference curves cannot intersect.

• This would violate the assumption of transitivity.
• If consumer preferences show A ~ B, and B ~ C, then A ~ C.
Indifference Curves Cannot Intersect with Each Other
Second Example: Scores Generated by a Utility
Function
Indifference curve for bundles a score
of 500.
Perfect Substitutes—1
Perfect substitutes:
• The consumer is completely indifferent between two
goods.
• Will exhibit a constant MRS
• Gasoline: 1 gallon of Exxon gas is just as good as 1 gallon
of Chevron gas.
• Milk: 2 pints of milk are just as good as a quart of milk.
Perfect Substitutes—2
 Exercises To Solve
(a) Shirley Sixpack is in the habit of drinking beer each evening while watching “The Best of
Bowlerama” on TV. She has a strong thumb and a big refrigerator, so she doesn’t care about the size
of the cans that beer comes in, she only cares about how much beer she has. Draw some of Shirley’s
indifference curves between 16-ounce cans and 8-ounce cans of beer.

(b) Lorraine Quiche likes to have a beer while she watches “Masterpiece Theatre.” She only allows
herself an 8-ounce glass of beer at any one time. Since her cat doesn’t like beer and she hates stale
beer, if there is more than 8 ounces in the can she pours the excess into the sink (She has no moral
scruples about wasting beer.). Draw some of Lorraine’s indifference curves on the same graph where
you have drawn Shirley’s indifference curves. Distinguish indifference curves for both on the same
graph by using a different colour of pencil/pen.