1. Rational Consumer Choice Chapter 3

2. Rational Choice Theory Assumption that consumers enter the market place with clear preferences Price takers Consumers allocate their incomes in order to maximize benefit

3. Rational Choice Theory: Maximizing Benefit Step One: Describe the various combinations of goods the consumer is able to buy Step Two: Select the feasible combination that is preferred to all others

4. The Budget Constraint & the Affordable Set Bundle: A particular combination of two or more goods Budget Constraint: Set of all bundles that can be purchased with given income and prices, if all income is spent

5. Budget Shifts Due to Price or Income Changes Consumer income and price of goods determine the slope and position of the budget constraint If either factor changes, then there is a new budget constraint

6. Budgets with More Than Two Goods Composite Good: Hypothetical construct representing all other goods on which income could be spent Relative prices to each other held constant

7. Kinked Budget Constraints A quantity discount gives rise to a nonlinear budget constraint

8. Consumer Preferences Preference Ordering: The consumer ranks all possible consumption bundles in order of preferences Four properties:  Completeness  More-Is-Better  Transitivity  Convexity

9. Consumer Preferences Properties allow economists to construct analytical representation of preferences Needed for budget allocation problem

10. Consumer Preferences Preference ordering is complete if the consumer is able to rank all possible combinations of goods and services More-Is-Better implies other things are equal, more of a good is preferred to less

11. Consumer Preferences Transitivity occurs when a consumer:  Prefers bundle A to bundle B  Bundle B to bundle C  Bundle A to bundle C Convexity implies that mixtures of goods are preferred to extremes

12. Indifference Curves Set of bundles among which the consumer is indifferent Graphical representation of consumer’s preferences Indifference maps are a sample of the set of consumer indifference curves used as a summary of preference ordering

13. Preference Ordering There are four properties of preference ordering: 1. Indifference curves for goods are ubiquitous 2. Curves are downward sloping 3. Curves cannot cross 4. Curves become less steep as we move downward and to the right along them

14. Tradeoffs Between Goods Marginal Rate of Substitution (MRS):  Rate at which the consumer is willing to exchange good X for good Y along the IC  Equal to the negative of the value of the slope of the IC

15. The Affordable Bundle The best affordable bundle is the most preferred of those that are available The indifference map tells us how the various bundles are ranked in order of preference The budget constraint tells us which bundles are affordable

16. Corner Solutions The best affordable bundle doesn’t always occur at the point of tangency In a choice between two goods, a case in which the consumer does not consume one of the goods

17. Changes in Tastes, Preferences & Goods Over time people’s preferences can change Goods that were once available become obsolete New goods appear on the market, thus changing preferences