Consumer Choice TheoryPrinciples of Microeconomics 2023

Boris Nikolaev

Utility Analysis

Utility = happiness (satisfaction from consumption)

1. subjective.

2. hard to measure.

3. preferences are stable.

mmm…

The Law of Diminishing Marginal Utility

# of units consumed Total Utility (TU) Marginal Utility (MU)

0 0

1 10

2 8

3 2

4 0

5 -2

Marginal Utility: utility from consuming one more unit of the good.

Total Utility: utility from consumption so far.

The Demand Curve

The ModelTwo goods: X, Y px = price of x px =price of y

How much X, Y should you consume?

U =f(X,Y) utility function

The budget constraint

Assumptions

1. Perfect Information

2. “More is better”

3. Perfectly rational maximizing utility

Master’s level explanation

• How we use calculus to solve this problem.

The Budget Constraint

PreferencesWe use indifference curves to measure preferences.

= all combinations of x, y that makes you equally happy.

Properties of indifference curves

1. As you consume more (go NE) you become happier.

2. There are infinitely many indifference curves (they never intersect).

3. Downward sloping (convex shape)

Marginal Rate of Substitution

MRS = - slope of ind. curve

Minimum amount of good y you would accept in a trade for one unit of good x

The Tangency Condition

the tangency condition

The slope of the indifference curve = - MRS = - Px/Py

Economic Efficiency

• Pareto Superior: change in allocation of resources is PS if we can make somebody better off without making somebody worse off.

• Pareto Optimal: an allocation is PO if no one could be made better off without making somebody else worse off.