CENTRE FOR POLICY STUDIESUNIVERSITY COLLEGE CORK

EC2204TUTORIAL 5

W\S 12\11\2012

Academic Year: 2012/2013 Instructors: Brenda Lynch and P.J. Hunt

Contact: brendalynch@ucc.ie or p.hunt@ucc.ie

Consumer Choice

Consumer Preference & Indifference Maps

 The basic assumptions underlying

the theory of consumer preferences are as follows:

1) Completeness: for any two market baskets, either the consumer prefers one to the other or is indifferent between them;

2) Transitivity: for any three market baskets, if the first basket is preferred to a second one, and the second one is preferred to a third one, then the first basket must also be preferred to the third one; and

3) More is better: if the first basket contains more of any good than the second basket, the first basket is preferred to the second.

Indifference Curves (maps)

With only two goods in a market, we can represent our hypothetical consumer’s preferences by drawing a two-dimensional indifference curve.

Fig. 3.1

Clothing, units per week

Food, units per week

0 B

0 A

0 D

Every basket on the indifference curve drawn in Figure 3.1 gives the consumer equal satisfaction. Basket A is just as desirable as basket B or basket D.

However, every basket lying above the curve in Figure 3.1 has to have more units of F, more units of C, or more of both, and must be better than basket A. (impossible given current resources)

Every basket lying below the curve has to have fewer units of F or C or both, and must be worse than A. (using less than the available resources)

Budget ConstraintsThe budget constraint faced by the

consumer limits her spending to a maximum of what her income will allow. If F and C are the quantities of the two goods, the budget line is;

Pf F + Pc C = I

Where Pf is the price per unit of food, Pc is the price per unit of clothing, and I is the total income available.

Figure 3.3 shows a typical budget line. The intercepts of the budget line are I/PC and I/PF (the maximum amount of clothing or food that can be purchased if all income is spent on clothing or food).

The slope of the budget line is minus the price ratio, - Pf/ Pc. A change in income causes a parallel shift in the budget line. A change in prices alters the slope of the budget line.

FIG. 3.3 CLOTHING

I/PC

IC0

I/PF FOOD

Slope = -Pf/Pc