ECN21

• Utility


  Satisfaction or happiness
• Total Utility (TU)


  Total satisfaction or the total unit of satisfaction through the consumption of a specific good or service
• Marginal Utility (MU)


  The utility or dissatisfaction from the last unit of consumption
• Utility Schedules


  • Consumption (Q)
  • Total Utility (TU)
  • Marginal Utility (MU)
• As the consumption level increases, a positive MU increases TU, while the opposite is true when MU is negative
• The consumer is only willing to consume up to the point of maximum satisfaction from where an additional unit of consumption no longer yields additional satisfaction
• Law of Diminishing Marginal Utility


  • As consumption increases, the MU derived from each additional unit declines
• Indifference curve


  Shows the varying combinations in the consumption of commodities that yield the same level of TU
• Law of Diminishing Marginal Rate of Substitution


  • The consumer's willingness to part with less and less quantity of one good in order to get one more additional unit of another good
• Budget Line


  Contains infinite points of combinations of the commodity items that yield the same budget it can buy at a given prices
• An inversely proportional relationship exists between the two commodities along the budget line given the budget and prices as constant
• A directly proportional relationship exists between the levels of the budget line and the overall purchase quantities of the commodity items
• The point along every budget line that coincides with the straight line drawn from the point of origin of the graph represents the same ratio of combination between the commodity units
• max Qf


  B/Pf maximum for f (food)
• max Qc


  B/Pc maximum for c (clothing)
• "Optimum combination": 'The quantities of the commodities at any point along a budget line indicate purchasing capacity. This point, together with the said purchase quantities coincides with that of an indifference curve and hence, meets the latter's budget requirement.'
• The figure shows three of the infinite indifference curves that are strategically placed within the purchasing power of the budget line. Indifference curve I2 is attainable at either point of intersection (A and B) with the budget line as on any curve I3. On the other hand, I3 is attainable at the point where it is tangent to the budget line (point A). Furthermore, no difference curve about I3 is attainable with the same budget in the absence of any point of coincidence.

  
• The budget yields the maximum level of satisfaction at the point where it is tangent (Point A) to indifference curve I3. This is the highest level indifference curve corresponding to the highest level of satisfaction that the budget line can afford.

  
• "Optimum combination": 'The concept of optimum combination implies that a consumer can increase the level of satisfaction, despite a fixed income, by altering the consumption mix.'
• For example, consumers minimize their consumption of luxurious items in favor of the more basic ones during an economic crisis.
• Income effect


  The change in the consumption of goods based on income. This means consumers will generally spend more if they experience an increase in income. They may spend less if their income drops.
• ↑ Income


  ↑ Consumption
• ↓ Income


  ↓ Consumption
• The income effect can be both direct and indirect. When a consumer chooses to make changes to the way they spend because of a change in income, the income effect is said to be direct. For example, a consumer may choose to spend less on clothing because their income has dropped.
• An income effect becomes indirect when a consumer is faced with making buying choices because of factors not related to their income. For instance, food prices may go up, leaving the consumer with less income to spend on other items. This may force them to cut back on dining out, resulting in an indirect income effect.
• Substitution effect


  The substitution effect may occur when, due to a change in relative prices and finances, a consumer replaces one product with another. That might mean switching out cheaper or moderately priced items for ones that are more expensive.
• While the substitution effect changes consumption patterns in favor of the more affordable alternative, even a modest reduction in price may make a more expensive product more attractive to consumers.
• The substitution effect is not limited to consumers. When companies outsource part of their operations, they are demonstrating the substitution effect. Using cheaper labor in a different country or by hiring a third party results in a drop in costs. This nets a positive result for the corporation, but a negative effect for the employees who may be replaced.