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Principles and Preferences. Ch 4. Principles of Decision Making. Predicting consumers’ choices. Why do consumers make different choices? All are related to Preferences. - PowerPoint PPT Presentation
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Principles and PreferencesCh 4
Principles of Decision Making
Predicting consumers’ choices.
Why do consumers make different choices?
All are related to Preferences.
1st assumption about consumer behavior:
The Ranking Principle: A consumer can rank in order of preferences, all available alternatives.
A consumer is indifferent between 2 alternatives if he likes them both equally.
The 2nd assumption:
The Choice Principle: Among all available alternatives, the consumer selects the one that he ranks the highest.
this means that the consumer always attempts to achieve the highest level of satisfaction.
Consumer PreferencesDecisions are tend to be interrelated:
1.the enjoyment of one activity usually depends on other activities.
2.when spending money on one good, there is less money to spend on other goods.
Consumption bundle: a collection of goods an individual consumes over a given period.
Ranking Consumption BundlesOnly the consumer who can rank his own consumption bundles.
The 3rd Principle of consumer decision making:
The “More preferred to Less” Principle: When one consumption bundle contains more of every good than a second bundle, a consumer prefers the 1st bundle t the 2nd.
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BREAD
SOUPX’S ALTERNATIVES AND
PREFERENCES
NOTE: 1 IS THE HIGHEST
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BREAD
SOUPX’S ALTERNATIVES AND
PREFERENCES
1st BEST?
2nd BEST?
LEAST PREFERRED
BUNDLE?
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BREAD
SOUPX’S ALTERNATIVES AND
PREFERENCES
X GENERALLY PREFERS SOUP TO BREAD
MPL???
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BREAD
SOUPX’S ALTERNATIVES AND
PREFERENCES
X GENERALLY PREFERS SOUP TO BREAD
IN-TEXT-EXERCISE 4.1
Consumer Preferences with Finely Divisible Goods
When consumers can obtain any fraction of a unit (no matter how small).
We use indifference curves (IC)
It shows potential consumption bundles graphically.
each point represents a consumption bundle.
Good y
Good x
IC
Start with any alternative and always can find other alternatives that yield same level of utility (U).
IC shows all these alternatives.
How can we identify other consumption bundles that yield same (U)?
Good y
Good x
AC
E
D
F
H
G
according to MPL:
if we took ∆S, from (A) to (C), the consumer like A at least as well as C
Good y
Good x
AC
E
D
F
H
G
assume you move from C to D, (more of y), compensate by more than ∆S. the cons. is better off than when at (A). to (C), the consumer like A at least as well as C
Good y
Good x
AC
E
D
F
H
G
Since A is at least as well as C, and worse than D: there must be a bundle on line CD that is exactly as good as A which is E.
∆B
∆S
Allocation E lies on same IC running through A.
To reach bundle E from C, we add ∆B of Y.
Thus: Starting from bundle A, adding ∆B of Y compensates the loss of ∆S of X.
Good y
Good x
AC
E
D
F
H
G
Since F is at least as well as A, if we move from F to G, which is worse of than A, : there must be a bundle on line FG that is exactly as good as A which is H.
∆B’
∆S’
Good y
Good x
AC
E
D
F
H
G
The line connecting points E and H and other same points is called the IC.
∆B∆S’
Since more is preferred to less, 2 bundles cannot be equally attractive unless getting more of another means giving more of the other.
To get more of X, we give up some Y.
If we get more of both, we are better off.
Properties of IC
Properties of IC
IC are thin.
IC do not slope upward.
Separation
Properties of IC
y
x
ICA
B
IC are thin
FROM A TO B, B HAS MORE OF BOTH THAN A, B MUST BE P TO B,
BUT A AND B ARE ON SAME CURVE. THUS, ic CANNOT BE THICK
Properties of IC
y
x
IC
CD
IC do not slope upward
FROM C TO D, D CONTAINS MORE THAN C, D MUST BE P TO C,
BUT BOTH ON SAME CURVE!
Properties of IC
y
x
IC
MPL
POINTS TO THE NE ARE BETTER THAN SW BUNDLES.
Families of IC
y
x
ICs
MPL
Properties of IC
y
x
ICA
B
C
DD, A, AND C ARE INDIFFERENT
BUT D AND C LIE ON DIFFERENT IC!
