Consumer Behavior

 

Preferences

1. Utility: Measures individual preferences; greater preference indicates a higher level of utility.

2. Marginal utility: Additional utility gained from consuming an additional good. Marginal utility decreases as more and more of a good is consumed.

3. Marginal benefit: Willingness to pay to consume one more of a good. Consumers will buy the quantity of a good such that marginal benefit is equal to the price of the good.

4. An indifference curve illustrates all possible combinations of two goods that provide an individual with equal levels of utility.

   1. Indifference curves have a negative slope and they are convex.

   2. The slope of the indifference curve illustrates an individual’s preference for one good over another (how much of one good one would be willing to give up in order to receive more of the other good).

   3. Any point on a higher indifference curve is preferable to any point on a lower indifference curve.

 

Budget Constraint

1. The budget constraint shows what an individual can afford and is determined by the individual’s income and the prices of goods.

2. The constraint is allocated between two goods or between one good and all other goods.

3. The budget constraint will move outward (inward) for an increase (decrease) in income. The new constraint will show the new combinations of goods that are affordable to the individual.

4. An increase (decrease) in the price of a good will pivot the curve inward (outward). Less (more) of that good can be bought but total income is constant.

 

Utility Maximization

1. The budget constraint intersects many indifference curves but the best combination of goods is on the highest possible indifference curve, where the budget constraint is tangent to the indifference curve.

2. When utility is maximized, the ratio of the two goods’ marginal utilities will equal the ratio of the two goods’ prices.