CONSUMER PREFERENCE THEORY
Consumer
in making choices between the two period1 and period2 have some degree of
preferences attached to it choices. “Consumer preference is the rate at which
the consumer is willing and able to substitute second period for first period
consumption. Indifference curve is used to show consumer preferences in two
periods of consumption”.
The consumer is identified among the combination of
consumption bundles A, B, C, and D on Ic1.
If the consumer’s consumption is reduced from C to B,
it means that he requires his second period to be increased to keep him happily
ok.
If it is reduced from B to A, the consumer is needed
to be compensated in the second period, by increasing his consumption in the
second period.
The consumer prefers some points to others and he
would always desire to attain the highest indifference curve, because, there is
better satisfaction/utility derived from both periods.
The indifference curve IC2 is the most
preferred level that all consumers would want to attain.
The consumer satisfies the two periods (first and
second) properly on IC2 than IC1 and prefers point D to
any other point on IC1.
OPTIMIZATION
This is the ability of a consumer to maximally
combine his consumption between the two periods (first and second periods)
given available resources and budget constraint.
The consumer choices are represents on the
indifference curves IC1, IC2 and IC3.
IC2 is the highest attainable indifference
curve of the consumer, given his budget constraints and available resources in
the two periods.
The slope of the budget line is MRS and the slope of
the indifference curve is I+r.
We conclude by saying that at point e the slope of
indifference curve (I+r) is equal to slope of budget line MRS i.e. (I+r) = MRS.
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