The Theory of Consumer Behavior The principle assumption upon which the theory of consumer behavior and demand is built is: a consumer attempts to allocate his/her limited money income among available goods and services so as to maximize his/her utility (satisfaction).

Theories of Consumer Choice t The Cardinal Theory –Utility is measurable in a cardinal sense t The Ordinal Theory –Utility is measurable in an ordinal sense

The Cardinal Approach Nineteenth century economists, such as Jevons, Menger and Walras, assumed that utility was measurable in a cardinal sense, which means that the difference between two measurement is itself numerically significant. U X = f (X), U Y = f (Y), ….. Utility is maximized when: MU X / MU Y = P X / P Y

The Ordinal Approach Economists following the lead of Hicks, Slutsky and Pareto believe that utility is measurable in an ordinal sense--the utility derived from consuming a good, such as X, is a function of the quantities of X and Y consumed by a consumer. U = f ( X, Y )

Assumptions of the Ordinal Utility Approach t Complete Ordering; t More is Preferred to Less; t Transitivity or Consistency; t Substitutability or Continuity; and t Optimality

Tools of the Ordinal Approach t The Budget Line –Budget line illustrates the consumer’s income constraint by showing all of the combinations of quantities of X and Y that the consumer can buy. t The Indifference Curves –Indifference curves reveal consumer’s preferences for X and Y by identifying the combinations of X and Y which yield the same level of total utility.

Characteristics of Indifference Curves Indifference Curves are: t Continuous and Everywhere Dense; t Negatively Sloped; t Convex from the Origin; and t Indifference Curves Do Not Intersect.