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In this appendix, we provide a brief overview of the foundations of consumer

demand—how consumers allocate their spending among desired goods and

services. The analysis is important in its own right as a basis for downward-

sloping demand curves. Perhaps its greater importance lies in the broader

decision-making principle it illustrates. As we shall see, an optimal decision—

made either by a consumer or a manager—depends on a careful analysis of

preferences and trade-offs among available alternatives.

The Consumer’s Problem

Consider an individual who must decide how to allocate her spending between

desirable goods and services. To keep things simple, let’s limit our attention to

the case of two goods, X and Y. These goods could be anything from specific

items (soft drinks versus bread) to general budget categories (groceries versus

restaurant meals or food expenditures versus travel spending). The consumer

faces a basic question: Given a limited amount of money to spend on the two

goods, and given their prices, what quantities should she purchase?

INDIFFERENCE CURVES To answer this question, we will use a simple graphi-

cal device to describe the individual’s preferences. Imagine that we have asked

APPENDIX TO CHAPTER 3

Consumer Preferences

and Demand

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