Consumer Preference and Microeconomics

"Consumers, by definition, include us all." - John F Kennedy, 1962

Demand and Supply are perhaps the most fundamental concepts of microeconomics.  It is the consumers, like us, who create demand and the underlying economic theory of consumer demand is that we, as consumers always choose the best bundle of goods that we can afford. 

The microeconomic model for consumer preference begins with a simplifying assumption (that economics is famous for) - Consumers have to make a choice between two goods, say Product 1 and Product 2, whose quantities x₁ and x₂ they choose to consume. This is known as the customer’s consumption bundle.

 Consumption Bundle- (x_1, x₂₎

For example, if I as a consumer make a choice between two fruits- Apples(A) and Oranges (O), and if I choose to consume 6 Apples and 3 Oranges, my consumption bundle would be X= (6A, 3O).

Now, an important factor that is an integral part of consumer preference, is the budget that the consumer has, which in microeconomics is stated to be the consumer’s budget constraint.

If we know that the prices of Good 1 and Good 2 are p₁ and p₂ respectively, then the budget constraint (B) of the consumer can be stated mathematically in the form of an equation-

p₁ x₁+ p₂ x₂  ≤ B

This is an intuitive assumption, as the purchasing power of the consumer is influenced by the income that a person has. If my budget is lower than the price of the goods I wish to purchase, then I wouldn’t be able to afford it. In microeconomics, a consumer’s budget ‘line’ is the set of bundles whose cost is exactly equal to our budget.

For example, if p₁₌ Rs. 20 and p₂₌ Rs. 10 and my consumption bundle is (6A, 3O), then my budget has to be Rs.120. This can be represented graphically as-

The line shown in the graph is the budget line. It means that with the budget of Rs.120, he can purchase 6 Apples and 3 Oranges. If his income increases, there will be a proportionate rightward shift in his budget line, and if his income decreases, there will be a proportionate inward shift in his budget line. Using his entire budger, if he wishes he can purchase 12 Oranges ‘or’ purchase 6 Apples. Another interesting observation is that the slope of the budget line shows us the opportunity cost- how much of apples do we need to give up to purchase oranges and vice versa. Any point above the budget line is unfeasible, as we can’t afford that and any point below is not preferred, as a homo economicus always maximizes their satisfaction. This brings us to the next concept in Consumption Preference- Utility.

Now, the consumer derives utility from a commodity using two main approaches- a cardinal approach and the ordinal approach. The cardinal approach is a quantitative one, wherein we assign utils to products, according to our preference. The ordinal approach is when consumers rank the goods according to their preference, qualitatively.

To understand this better, let’s include another consumption bundle- (y₁, y₂). Let’s say y₁ is Grapes (G) and y₂ is Strawberries (S), if I choose to consume 4 Apple Juices and 2 Orange Shakes, my consumption bundle would be-

Y= (4G, 2S)

Now, let’s understand some fundamental axioms of consumer preference, using the two bundles we have presented.

Ø  Completeness- We assume that the consumer can now compare bundles X & Y. That means consumer prefers X= (6A, 3O) over Y=(4G,2S) or vice versa. There can also be a situation wherein the consumer is indifferent between X and Y.

Ø  Reflexivity- The consumer assumes that any bundle is at least as good as itself. This is a self-explanatory and trivial axiom.

Ø  Transitivity-   If we introduce another consumption bundle, say Z=(Z_1,Z₂) and the consumer prefers bundle Y over Z. If, the consumer prefers bundle X over bundle Y, then the axiom states that he/she will prefer X over Z.

These 3 and a few more technical assumptions are sufficient to explain consumer preference. Now that we have understood the basic principles on which the model of consumer choice is built, we can finally delve into a graphical representation of it- Indifference Curves. 

Each and every one of us has different preferences and choices. My preference for the goods in a bundle can be different to yours. The utility/ satisfaction we derive from the goods is different for each one of us and so, we all have different indifference curves. This is what makes the microeconomic analysis of consumer choice,  very detailed and optimal- it takes into account the subjectivity of consumer choice.

Now, all points on the indifference curve represent my indifference between the two products. My IC curve is I_2, my friend’s is I_1, and my neighbour’s is I₃. In the case of our Bundle X, my IC represents the indifference I have between apples and oranges. How much am I willing to tradeoff apples for oranges. The point where my IC intersects the budget line we had previously constructed, is the point where I achieve optimal utility, hence, I as a consumer will prefer that point.

What I have put forward is a very basic framework of consumer preference. In microeconomics, the theory of consumer preference develops into a much deeper and nuanced analysis of consumer preferences. I look forward to delving deeper into and building on this basic microeconomic model of consumer preferences.