This document summarizes key concepts related to consumer choice theory in microeconomics, including: 1) Budget constraints define all combinations of goods that can be purchased given income. A budget line shows feasible combinations graphically. 2) Utility is maximized when marginal rate of substitution between goods equals their price ratio, satisfying both budget and preference constraints. 3) Managers can strategically influence choices by changing preferences through advertising, or the budget line through pricing, like discounts or quantity incentives.

1. Consumer Choice –II
Microeconomics
Prof. Ashutosh Tripathi

2. Budget constraints
• Given by a budget line indicating all
combinations of two commodities for
which total money spent equals total
income.

3. Budget Line F + 2C = $80
C
F/P
P
F
C -
2
1
-
/ 




Slope
10
20
(I/PC) = 40
Budget constraints
Food
(units per week)
40 60 80 = (I/PF)
20
10
20
30
0
A
B
D
E
G
Clothing
(units
per week)
Pc = $2 Pf = $1 I = $80
What will happen to the
budget line if there is
rationing of food (e.g.,
you can’t buy more than
40 units)?

4. Budget Line F + 2C = $80
(I/PC) = 40
Budget constraints
Food
(units per week)
40 60 80 = (I/PF)
20
10
20
30
0
Clothing
(units
per week)
Rationing constraint
Feasible
set

5. Example of multiple constraints on consumer
Choice (from text)

6. Effect of income change
Food
(units per week)
Clothing
(units
per week)
80 120 160
40
20
40
60
80
0
A increase in
income shifts
the budget line
outward
(I = $160)
L2
(I = $80)
L1
L3
(I =
$40)
A decrease in
income shifts
the budget line
inward

7. Effect of price changes
Food
(units per week)
Clothing
(units
per week)
80 120 160
40
40
(PF = 1)
L1
An increase in the
price of food to
$2.00 changes
the slope of the
budget line and
rotates it inward.
L3
(PF = 2)
(PF = 1/2)
L2
A decrease in the
price of food to
$.50 changes
the slope of the
budget line and
rotates it outward.

8. Effect of proportional
price changes
• If the two goods increase in price,
but the ratio of the two prices is
unchanged, the slope will not change.
• However, the budget line will shift
inward, but parallel to the original
budget line.

9. Two conditions for
optimal consumer choice
1) Must be located on the budget line.
2) Must give the consumer the most
preferred combination of goods and
services (i.e., maximum satisfaction).

10. U2
Consumer Choice
Pc = $2 Pf = $1 I = $80
Budget Line
A
At market basket A
the budget line and the
indifference curve are
tangent and no higher
level of satisfaction
can be attained.
At A:
MRS =Pf/Pc = .5
Food (units per week)
Clothing
(units per
week)
40 80
20
20
30
40
0

11. • When consumers maximize satisfaction:
C
F/P
P
MRS 
C
F
C
F /P
P
/MU
MU 
Marginal utility and
consumer choice
• Since MRS is also equal to the ratio of the
marginal utilities of consuming F and C:

12. • The equation for utility maximization can
be alternatively expressed as:
C
C
F
F P
MU
P
MU /
/ 
Marginal utility and
consumer choice

13. • Total utility is maximized when the
budget is allocated so that the
marginal utility per dollar of
expenditure is the same for each
good.
• This is referred to as the equal
marginal principle.
Marginal utility and
consumer choice

14. A Corner Solution
Ice Cream (cup/month)
Frozen
Yogurt
(cups
monthly)
B
A
U2 U3
U1
A corner solution
exists at point B.

15. Condition for corner
solution
•MUX/PX > MUY/PY
•Implications of corner solution:
brand loyalty at any price?

16. HOW MANAGERS CAN STRATEGICALLY
INFLUENCE CONSUMER CHOICES
• Managers can change consumer choices by
influencing preferences through
advertising strategies and by influencing
the budget line through pricing strategies.
• Example: Coupon that offers a discount of
$18 to food customers who spend at least
$180 in one store
– Figure 3.9 in text shows the equilibrium bundle
in the absence of the coupon on a graph that
assumes that the budget is $200 and price of
clothing (Y) and of food (X) are both equal to
$1.

17. HOW MANAGERS CAN STRATEGICALLY
INFLUENCE CONSUMER CHOICES
Clothing
Groceries
180 200 218
With new truncated budget line, an equilibrium at
higher indifference curve is expected, if indifference
curves have inclinations towards the groceries axis.
But no utility improvement may occur if preferences
are relatively tilted towards the clothing axis.

18. HOW MANAGERS CAN STRATEGICALLY
INFLUENCE CONSUMER CHOICES
• Example: Quantity discount (Figure
3.11 in text)
– If Ms. Popovich buys from one to three
donuts, they cost $0.50 each. Six
donuts cost a total of $2.00. Seven
donuts cost $2.00 plus $0.50. A dozen
donuts cost $3.00. Ms. Popovich has
$4.00 to spend on donuts or on "all
other things."

20. HOW MANAGERS CAN STRATEGICALLY
INFLUENCE CONSUMER CHOICES
• Example: Why most individuals prefer a cash gift
– If Ms. Popovich's preferences include
indifference curve U2, then one unit of the gift
good would leave her utility unchanged, while a
cash gift would increase her utility.
– In the case described above, a cash gift with
value A1 – A0 would provide more utility
(increase from U0 to U1) than a gift valued at
A2 – A0, which would leave utility unchanged.
– This analysis does not account for the
sentimental value.

22. HOW MANAGERS CAN
STRATEGICALLY INFLUENCE
CONSUMER CHOICES
• Example: Gift cards instead of cash
– At best, they are not universally
accepted.
– At worst, they tie the recipient to a
particular store.
– They're like money but not as useful
because they are not as fungible.

23. Other
goods
(Y)
II
I
0
A
C
B F
D
E
Pizza
(X)
0.5 1 2
A buy-one, get-
one free pizza
deal.
A Classic Marketing
Application

24. The trust fund shifts the budget line
More Application 1:
College Trust Fund
P
Q Education ($)
Other
Consumption
($)
U2
A
U1
A: Consumption before the trust fund
B
B: Requirement that the trust fund
must be spent on education
C
U3 C: If the trust could be spent on
other goods – i.e., unconstrained

25. B
20,000
A
Gasoline
(gallons per year)
Spending
on other
goods ($) 20,000
5,000
U1
C
15,000
2,000
D
With a limit of
2,000 gallons,
the consumer moves
to a lower
indifference curve
(lower level of utility).
18,000
U2
More Application 2: Gasoline
Rationing
Will the consumer
be necessarily worse
off at D?

26. More Application 3: Labor-leisure
choice, where an individual appears in
a dual role – as a consumer of leisure
& as a supplier of labor for wages
(both income & leisure are goods)

27. CONCLUSION:
Do People Really Think This Way?
• Most people do not make spending decisions
by writing down their budget constraints and
indifference curves.
• Yet, they try to make the choices that maximize
their satisfaction given their limited resources.
• The theory in this chapter is only intended as a
metaphor for how consumers make decisions.
• It does fairly well at explaining consumer behavior
in many situations, and provides the basis for more
advanced economic analysis.