Question

In: Economics

Consumer purchasing behavior is driven by consumer preferences. The state legislators would like to better understand...

Consumer purchasing behavior is driven by consumer preferences. The state legislators would like to better understand consumer preferences and the requirements needed to analyze consumer preferences. What does restricting consumer preferences to be transitive mean, and what are the implications of transitivity for consumer indifference curves?

b. What is the relationship between the Diminishing Marginal Rate of Substitution and the Law of Diminishing Marginal Utility?

Solutions

Expert Solution

Consumer preference is defined as a set of assumptions that focus on consumer choices that result in different alternatives such as happiness, satisfaction, or utility. The entire consumer preference process results in an optimal choice. Consumer preferences allow a consumer to rank different bundles of goods according to levels of utility, or the total satisfaction of consuming a good or service.It is important to understand that consumer preferences are not dependent upon consumer income or prices. So a consumer's capacity to buy goods does not reflect a consumer's likes or dislikes.

Transitivity means that the consumer's preferences are consistent in the sense that if she prefers bundle B to A, and prefers bundle C to B, then we know she will prefer C to A without even asking her. The implication of the transitivity assumption is that indifference curves can't cross each other.

Diminishing marginal utility is assumed when comparing marginal utility of two goods which is why the marginal rate of substitution curve has a convex shape. To say that the marginal rate of substitution is diminishing is to say that the ratio is changing as one moves along the convex shaped curve from one point to another. This reflects the fact that both goods being considered are in fact goods and that they are in some respect complements such that more of one without more of the other faces a diminishing return.

Usually, marginal substitution is diminishing, meaning a consumer chooses the substitute in place of another good rather than simultaneously consuming more. The law of diminishing marginal rates of substitution states that MRS decreases as one moves down a standard convex-shaped curve, which is the indifference curve.


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