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Consumer Behavior

Course Taught by : Tanmoyee Banerjee(Chatterjee) Professor Department of Economics,Jadavpur University Kolkata 700032

Consumers’ decision making

 Rationality  We consider individual decision taker as the basic unit of analysis.  Second is the hypothesis that this decision-taker is rational.  In rational decision-taking:  (a) The decision-taker sets out all the feasible alternatives, rejecting any which are  not feasible;  (b) He takes into account whatever information is readily available, or worth collecting,  to assess the consequences of choosing each of the alternatives;  (c) In the light of their consequences he ranks the alternatives in order of preference,  where this ordering satisfies certain assumptions of completeness and  consistency  (d) He chooses the alternative highest in this ordering, i.e. he chooses the alternative  with the consequences he prefers over all others available to him.

Axioms of preferences 1. Completeness:  Consumer can rank(compare)all available consumption bundles.  So for any two bundles of goods A and B he can establish a preference ordering  And choose one of the following possibilities:  a) A is preferred to B (A ≻ B, or A ≽ B) ,  b) B is preferred to A (B ≻ A, or B ≽ A) ,  c) A and B are equally good, consumer is indifferent between A and B(A ∼ B).  Completeness implies that there is no hole in the consumption space.

 2. Transitivity:  For any three consumption bundles A, B and C it is valid that if consumer prefers A to B ,and he prefers B to C ,then he must prefer A to C. if A ≻ B and B ≻ C then A ≻ C  Consumer is consistent in his preferences.  No bundle can exist in two indifference set. For suppose that x ′ ∼ x ″, so that x ″ belongs to the indifference set of x ′; and also that x ″ ∼ x ′″, so x ″ belongs to the indifference set of x ′″. If x ′ ∼ x ′″, then there is no problem, since all three bundles are in the same indifference set. But suppose x ′″ ≻ x ′. Then x ″ must be in two indifference sets, that of x ′ and that of x ′″. But then we have x ′ ∼ x ″, and x ″ ∼ x ′″ but x ′″ ≻ x ′ which violates the assumption of transitivity. Thus given this assumption, no

bundle can belong to more than one indifference set: the transitivity assumption

implies that indifference sets have no intersection.

 5. Non-satiation. More is better  A consumption bundle x  will be preferred to x  if x  contains more of at least one good and no less of any other, i.e. if x ≻ x .

 All bundles in the area B (including the boundaries, except for x  itself) must be preferred to x .  All points in the area W (again including the boundaries except for x ) must be inferior to x .  The points in the indifference set for x ′ (if there are any besides x ′) must lie in areas A and C.  There must be trade-off or substitution between commodities that lie in same indifference level.  That is, in a two good framework, the set of points that will lie on same indifference curve must contain more of one commodity but less of others relative to each other.  Implication: Indifference curves cannot be thick and are negatively sloped

5. Continuity  The graph of an indifference set is a continuous surface.  That along an indifference curve both goods can be substituted continuously.  This implies that the surface, or curve in two dimensions, has no gaps or breaks at any point.  In terms of the consumer’s choice behaviour, given two goods in his consumption bundle, we can reduce the amount he has of one good, and however small this reduction is, we can always find an increase in the other good which will exactly compensate him, i.e. leave him with a consumption bundle indifferent to the first.

The indifference curves cannot

intersect

 In the diagram  A≻ 𝐵 𝑎𝑛𝑑 𝐶 ≻D  D∼ 𝐴 𝑎𝑛𝑑 𝐶 ∼ 𝐵  A≻ 𝐵 ∼ 𝐶 implies A ∼ 𝐶 ≻D  Hence A ≻D. However, D∼ 𝐴.  This is a contradiction.  Thus, indifference curves cannot intersect.

A

B

C

D

A Strictly Convex Set A non Convex Set A Convex Set

Convexity  Suppose indifference curve I ′ contains points that are indifferent to the commodity bundle x ′.  The better set for the point x ′ is the set of points on the indifference curve I ′ and in the shaded area, and this is drawn as strictly convex.  The strict convexity of better set imposes a restriction on the curvature of the indifference curve. if we move the consumer along the indifference curve leftward from point x ′, reducing the quantity of x 1 by small, equal amounts, we have to compensate, to keep him on the indifference curve, by giving him larger and larger increments of x 2.  In other words, the curvature implies that the smaller the amount of x 1 and larger the amount of x 2 held by the consumer, the more valuable are marginal changes in x 1 relative to marginal changes in x 2. This is a plausible feature of consumer preferences.

Families of Indifference curves Due to six assumptions, we can represent the preference ordering of the consumer by a set of continuous convex-to-the-origin indifference curves or surfaces, such that each consumption bundle lies on one and only one of them.

Properties of indifference curves Bundles on indifference curves further from the origin are preferred to ones on indifference curves closer to the origin

• Follows from the monotonicity/ MIB/Non-satiation assumption. Indifference curves are downward sloping
• Follows from the more is better- Every commodity is a good Indifference curves cannot cross
• Follows from more is better and transitivity assumptions Indifference curves are continuous
• Follows from the completeness assumption Indifference curves are convex to the origin
• Preferences are convex