Week 3 chapter notes

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University of Toronto Scarborough
Economics for Management Studies

Chapter 3 Consumer Behaviour Notes N theory of consumer behaviour a description of how consumers allocate their incomes among the purchases of different goods and services to maximize their well-being Consumer Behaviour N consumer behaviour is best understood in 3 distinct steps: 1. Consumer Preferences: first step is to find a practical way to describe reasons people might prefer one good over another. 2. Budget Constraints: of course, consumers also consider prices. In Step 2, therefore, the fact that consumers have limited incomes which restrict the quantities of goods they can buy is taken into consideration. 3. Consumer Choices: given their preferences and limited incomes, consumes choose to buy combinations of goods that maximize their satisfaction. These combinations will depend on the prices of various goods. N consumers do not always make purchasing decisions rationally N sometimes, they buy on impulse, ignoring or not fully accounting for their budget constraints (and going into debt as a result); or they are unsure about their preferences or are swayed by the consumption decisions of others, or even by changes in mood N if consumers do behave rationally, it may not be feasible for them to account fully for the multitude of prices and choices seen N economists have recently been developing models of consumer behaviour that incorporate more realistic assumptions about rationality and decision making, called behavioural economics and draws heavily from findings in psychology and related areas 3.1 Consumer Preferences Market Baskets N market basket (or bundle) list with specific quantities of one or more goods N a market basket might contain various food items; or quantities of food, clothing, ad housing that a consumer buys each month N although selections may sometimes be arbitrary, consumers usually select market baskets that make them as well off as possible Some Basic Assumptions about Preferences N theory of consumer behaviour begins with 3 basic assumptions about peoples preferences for 1 market basket versus another: 1. Completeness: Preferences are assumed to be complete. In other words, consumers can compare and rank all possible baskets. Thus, for any 2 market baskets A and B, a consumer will prefer A to B, will prefer B to A, or will be indifferent between the 2. By indifferent it is meant that a person will be equally satisfied with either basket. Note that these preferences ignore costs. 2. Transitivity: Preferences are transitive. Transitivity means that if a consumer prefers basket A to basket B and basket B to basket C, then the consumer also prefers A to C. Transitivity is normally regarded as necessary for consumer consistency. 3. More is better than less: Goods are assumed to be desirablei.e., to be good. Consequently, consume
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