Consumer Preferences
Market basket (bundle) – List with specific quantities of one or more goods.
The theory of consumer behavior begins with three basic assumptions about people’s preferences for one market basket versus another.
- Completeness – Consumers can compare and rank all possible baskets.
- Transitivity – If consumer prefers basket A to basket B and basket B to basket C, then consumer also prefers A to C.
- More is better than less – More is always better, consumers are never satisfied
- Diminishing marginal rate of substitution – an indifference curve is convex if the MRS diminishes along the curve
Indifference curve – Curve representing all combinations of market baskets that provide a consumer with the same level of satisfaction. Indifference curves cannot intersect.
Indifference map – Graph containing a set of indifference curves showing the market baskets among which a consumer is indifferent.
Marginal Rate of Substitution(MRS) –
Maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good.
Perfect substitutes – Two goods for which the marginal rate of substitution of one for the other is a constant.
Perfect complements – Two goods for which the MRS is zero or infinite; the indifference curves are shaped as right angles.
Utility - numerical score representing the satisfaction that a consumer gets from a given market basket.
Ordinal utility function – Utility function that generates a ranking of market baskets in order of most to least proffered.
Cardinal utility function – Utility function describing by how much one market basket is preferred to another.
