4004 WordsAug 3, 201117 Pages

Supplement to Unit - II
BEHIND THE DEMAND CURVE: THE THEORY OF CONSUMER CHOICE
Here, the purpose is to explain the derivation of the demand function and to provide an understanding of the consumer decision-making process.
Consumer Preferences Individuals make choices based on their personal tastes and preferences. Tastes and preferences are shaped by many factors. Some of the factors are family environment, physical condition, age, sex, education, religion, and location. In the analysis that follows, tastes and preferences will be viewed as a given, and discussion will focus on how those tastes and preferences are transformed into consumption decisions.
Bundle B
2 units of X
6 units of Y
Bundle A
5 units of X
2 units of Y In*…show more content…*

The assumption that individuals are capable of ranking their preferences implies that indifference curves exist. The assumption of non-satiation assures that the curves will have a negative slope. This is easily shown by considering a curve with positive slope, such as the curve passing through point S in Figure – 2. Pick any point on the curve, such as R. Note that point S denotes a bundle with more of both goods X and Y than point R. But because of the non-satiation assumption, having more of both goods implies that S is preferred to R. Thus, the two points cannot be on the same indifference curve. Hence, indifference curves must be downward sloping. Transitivity and non-satiation guarantee that two indifference curves will not intersect. This can also be seen from Figure – 2, which shows two indifference curves crossing at point J. Consider points K and L. The bundle denoted by K has more of both goods than L and hence must be preferred to L. Because J and L are on the same indifference curve, transitivity requires that K be preferred to J. But this is not true; J and K are on the same indifference curve. Thus the assumption of transitivity has been violated because preferences are not consistent. The assumption of transitivity is always violated when indifference curves intersect. The assumption that consumers will be willing to give up successively fewer units of one good in

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