Introduction of Economics: Preferences

and Utility
Why think of consumer
preferences/behaviors?
Can you relate this with the case?
Consumer Preference for Rice
• Marketing strategies for HYV
• Characteristics of the market:
• Understanding the market structure for agricultural products
• Intervention of the government, Supply> Demand
• Characteristics of the Good:
• Highly substitutable
• Varieties are available
• Can we create a loyal consumer base after understanding their preferences?
• Characteristics of the consumers: Profiling of the consumers
• Urban/ Semi-urban- purchasing pattern will vary- retail vs. fair price shops
• Occupation- calorie requirement will vary
• Income- Revealed preferences
Consumer Preference for Rice (Semi-
Urban)
• Varieties of Rice- Families consumed only one variety (bundle of
attributes but not goods)
• Akkulu- consumed by 75% of the consumers- preferred by small and high
income group
• KK Kulu and Sambalu- preferred by high income group
• Factors influencing choices: preferred factors were (good taste, nutritive) and
(less price, nutritive)
• Attitude towards HYV
• 60% held a neutral view
• Nutritive value of rice had a significant relationship with the attitude
Consumer Preference for Rice (Semi-
Urban)
• Attitude towards IR8
• Polish: 85% perceived IR8 to be highly polished
• Nutritive value: Akkulu was perceived to have better nutritive value

• Relationship with income and consumption

• Relationship with profession and consumption
• Relationship with frequency of buying and consumption
If you were to sell rice, what would you do after
having the information?
Typical consumption bundles for two
goods
Properties of Consumer Preferences
• Complete Preference Ordering
1. I prefer bundle A to bundle B (denoted as A>B)
2. I prefer bundle B to bundle A (denoted as B<A)
3. I am indifferent between bundles A and B (denoted as A~B)
• Transitive Preference Ordering
If A>B, and B>C, then it follows that A>C
• Non-satiation
More of a good is always preferred to less
Why do you make consumption
preference?
Trade-offs
How much will the consumer consume?

Income $1,000 $10 $2

Budget Constraint
Slope of budget constraint

M is total income, is price of good X, is price of good Y

Rearranging,

Therefore is the slope of the budget line

Why do you consume goods and services?
NICM Cultural Committee
• Objective: Decide upon the pricing system with an objective of no
profit/ no loss in the long run
• No. of movies planned:
• 1st term: No. of movies = 13
• 2nd term: No. of movies = 13
• 3rd term: No. of movies = 10
• Supply: Capacity of the hall = 400
• Demand: Population is 400 and those who signed up = 310
• Alternative pricing options?
NICM Cultural Committee
• Three combinations:
• Option 1: Flat charge of Rs. 5 + Rs. 1.50 fee per show
• Option 2: Flat charge of Rs. 15 + Rs. 0.50 fee per show
• Option 3: Rs. 2.50 fee per show
If you were the committee member, what
would you do?
Utility
• Represents satisfaction that a consumer gets from a market basket
• A utility function shows an individual’s perception of the utility level
attained from consuming each conceivable bundle of goods
• A utility function can be represented by a set of indifference curves,
with a numerical indicator.
• IC is locus of points representing different bundles of goods, each of
which yields the same level of total utility
The Consumer’s Preferences
Ordinal and cardinal utility
• Ordinal utility: Utility function that generates a ranking of
market baskets in order of most to least preferred.
• But by how much one basket is preferred to other?
• Cardinal utility: Utility function that describes by how much one
market basket is preferred to another.
Cardinal utility
• Utility function u(F,C) = FC
• Utility at F = 5 and C = 5 would be 25.
• Draw other indifference curves for 2FC and 4FC.
Indifference Curves

• What will happen if indifference curve is upward sloping?

50
B
• One would always prefer ‘D’ as
40
compared to ‘A’ or ‘E’. So, there is no F D
indifference. 30
A
20
E C
• Assumption of ‘more is preferred to less’ is 10
violated. 0
10 20 30 40 Food (units
per week)
Indifference Curve

• Indifference curves cannot intersect.

WHY?
• ‘A’ and ‘B’ are on the same indifference

Clothing (units per week)

curve and so are ‘A’ and ‘C’. 50
• By the property of transitivity, one
40
must be indifferent between ‘B’ and
‘C’. 30 B
U2
• But, ‘B’ have more of both goods, so A
the assumption of more is preferred to 20 U1
C
less is violated. 10
0
10 20 30 40 Food (units
per week)
Marginal rate of substitution
• The downward sloping indifference curve shows
that consumer is willing to substitute one good for
obtaining more of other.
16 A
• Marginal rate of substitution: Amount of good that 14
a consumer is willing to give up in order to obtain 12 -6
one additional unit of another good.

Clothing (units per

10 B
1

• MRS = -∆C/∆F 8
-4
6 1
D
-2

week)
4
E
1
-1 G
2 1

0
1 2 3 4 5 6

Food (units per week)

Property of MRS: Convexity
• Diminishing marginal rate of substitution: Indifference curves are convex.

• As more of one good is consumed, the consumer would be willing to give up

fewer and fewer units of a second good to get additional unit of first good.
Bowed IC and changing MRS
Properties of the IC
• Higher indifference curves are preferred to lower ones
• Indifference curves are downward sloping
• Indifference curves do not cross
• Indifference curves are bowed inward
Extreme examples of ICs
Consumer chooses consumption of the two
goods so that the MRS equals the relative price
For an IC,
Therefore,
Consumers optimum in terms of utility
• MRS equals the ratio of marginal utilities

• Marginal utility per dollar spent on good = Marginal utility per dollar
spent on good Y

• If there are N goods , ,………

…….=
An Increase in Income
Inferior good
Price of Pepsi falls from $2 to $1 per liter?
Which statement do you find more
compelling?
• “Great news! Now that Pepsi is cheaper, my income has greater
purchasing power. I am, in effect, richer than I was. Because I am
richer, I can buy both more pizza and more Pepsi.”

• “Now that the price of Pepsi has fallen, I get more liters of Pepsi for
every pizza that I give up. Because pizza is now relatively more
expensive, I should buy less pizza and more Pepsi.”
Income and Substitution Effects
Deriving the demand curve
Do all demand curve slope downward?
Work Leisure Decision
What would you do if your wage increase?
• Work more?
• Work less?
How Do Interest Rates Affect Household
Saving?
What will be your change in saving when
interest rate increases?
Corner Solution
A corner solution takes place when the consumer consumes only one good.
Optimal bundle contains none of one of the goods.

The tangency condition may not hold at a corner solution

How do you know whether the optimal bundle is having interior optimum
or corner solution?
Graph the indifference curves
Check to see whether tangency condition ever holds at positive
quantities of X and Y
Example-Corner solution
Y
X + 2Y = 10

0 X
Thank you