1.  Consumer preferences

• Market basket - group of items that a consumer will consider for consumption

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a.  Assumptions about preferences

(1)  Completeness

• Consumers can compare and rank all possible baskets

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(2)  Transitivity

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(3)  Non-satiation

• More of a good is better than less

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• If all assumptions are met, individual is considered rational

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b.  Indifference curves

• Shows all market baskets where the consumer has the same level of satisfaction

• Utility - satisfaction that a consumer receives from a market basket

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• Indifference map - shows multiple indifference curves

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c.  Characteristics of indifference curves

(1)  Downward sloping

• Due to non-satiation

• If more of one received, less of the other must be received to balance gain in satisfaction

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(2)  Infinite number of indifference curves - one point through every point in space

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(3)  Higher indifference curve => higher utility

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(4)  Indifference curves can't intersect

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d.  Slope of indifference curve

• Marginal rate of substitution (MRS) = maximum amount of one good (Y) a consumer is willing to give up for one additional unit of another good (X)

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• Marginal utility - additional satisfaction received when consuming one additional unit of a good

• Marginal utility and the marginal rate of substitution:

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• Law of Diminishing Marginal Utility - as more of a good is consumed, the extra satisfaction received decreases

• Indifference curves tend to be convex - as more X is consumed, extra satisfaction received will be less => less Y needs to be given up

• Diminishing MRS - MRS decreases as more X consumed

• Individuals may have different preferences - may favor one good more than another

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e.  Unusually shaped indifference curves

(1)  Perfect complements - must use products in fixed proportions

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(2)  Perfect substitutes - consumer considers that products exactly the same

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(3)  Economic "bads" - one product is undesirable => less is preferred to more

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f.  Utility functions

• Mathematical expressions that assigns a level of utility to individual market baskets

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• Ordinal utility function - generates a ranking of market baskets

• Cardinal utility function - generates measures of utility, allows more precise comparison

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2.  Budget constraints

•  Budget line - all combinations of goods where the total spent is equal to income

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a.  Changes in income

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b.  Changes in price

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3.  Consumer choice

• Assume consumer tries to maximize utility => try to reach highest indifference curve

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• Equilibrium condition:

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• Corner solutions

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• Use of composite goods

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4.  Revealed preference

• Determine preferences from choices a consumer makes

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5.  Applications

a.  Rationing

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b.  Food stamps

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