Three parts and three assumptions of consumer behavior theory

Lecture 5. Consumer Behavior

Market adaptation to Demand and Supply changes in long-run and in short-run

Consumer behavior is best understood in 3 steps.

I. To examine consumer preferences (to describe how people might prefer one good to another)

II. To account the fact that consumers face budget constraints (they have limited incomes that restrict the quantities of goods they can buy)

III. To determine consumer choices (to put consumer preferences and budget constraints together).

In other words, given their preferences and limited incomes, what combinations of goods will consumer buy to maximize their satisfaction?

The theory of begins with three basic assumptions regarding people’s preferences for one market basket (just a collection of one or more commodities) versus another:

1) Preferences are complete (it means that consumer can compare and rank all market baskets, ignoring costs in this case).

2) Preferences are transitive (it means that if consumer prefer market basket A to market basket B, and prefer B to C, then the consumer also prefers A to C. This assumption ensures that the consumer preferences are rational).

3) All goods are “good” (i.e. desirable), so that leaving cost aside, consumers always more of any good to less. (It simplifies graphical analysis, despite of the fact that some goods are not desirable for consumer).

There are two approaches that may be used to explain an individual’s choice: cardinal and ordinal. A cardinal concept believes that individual preferences can be easily quantified or measured in terms of basic unit with the help of “utils”. By contrast, ordinal theory ranks market baskets in the order of most preferred to least preferred. Whereas this two approaches are different in the question of utility ranking they are compatible.

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