economics

• Utility


  Satisfaction gained from the consumption of goods and services
• Total utility (TU)


  The total satisfaction a person gains from all those units of a commodity consumed within a given time period
• Marginal utility (MU)


  The additional satisfaction gained from consuming one extra unit within a given period of time
• Diminishing marginal utility


  • As a person increases consumption of a product there is a decline in the marginal utility that is derived from the consumption of each additional unit
• Consumer Equilibrium


  The optimum level of consumption
• Marginal consumer surplus (MCS)


  The difference between what you are willing to pay for one more unit of a good and what you are actually charged
• Total consumer surplus (TCS)


  The excess of a person's total utility from the consumption of a good (TU) over the total amount that person spends on it (TE): TCS=TU–TE
• Rational consumer behavior


  The attempt to maximize consumer surplus
• Marginal utility and the demand curve for a good

  An individual's demand curve will be the same as their marginal utility curve for that good, where utility is measured in money
• Equi-marginal principle


  A consumer will get the highest total utility from a given level of income when the ratio of the marginal utilities is equal to the ratio of the prices
• Rational consumer


  Forms equilibrium where the last dollar spent on good A yields as much satisfaction as the last dollar spent on good B
• If current consumption levels suggest MUA > MUB

  Rational consumer will increase consumption of good A and reduce consumption of good B
• Consumer equilibrium


  Quantities of good A and good B where the equi-marginal principle is satisfied
• Deriving a demand curve

  1. Relate MU and P of good A to MU and P of any other good

  2. If price of good A falls, person would buy more of good A and less of all other goods until equation is satisfied

  3. Further changes in price of good A would bring further changes in quantity demanded to satisfy the equation

  4. Changes in demand represented by shift in demand curve
• Utility is an ordinal measurement (where ranking is possible) and not a cardinal measurement (where value can be measured)
• Marginal utility theory explains the relative prices of goods
• Marginal utility theory explains why water has a high value-in-use but low market value, while diamonds have a high market value
• Budget constraint


  Identifies which combinations of goods and services the consumer can afford with a limited budget, at given prices
• Slope of budget line

  Indicates the spending trade-off between one good and another - the amount of one good that must be sacrificed to buy more of another good
• Relative price of a good, opportunity cost of that good, and slope of budget line


  Have the same absolute value
• Rise in income with prices constant

  Budget line shifts parallel outward, real income rises
• Equal proportionate fall in prices with income constant


  Budget line shifts parallel outward, real income rises
• Price of one good falls, other price and income constant

  Budget line pivots outward, real income rises except at one point
• Income and price of one good rise, other price constant

  Budget line pivots inward
• Relative change in prices with income constant

  Budget line pivots
• At Point A, the real income remains unchanged


  This is a pivotal shift, as the slope of the line will change
• An increase in the price of movies


  Will cause a pivotal shift inwards
• The price of concerts halves and the price of movies doubles


  Will result in the relative prices to change and the slope to also change
• The price of concerts has not changed, but the relative prices have changed

  Also, since the income has risen, Max can buy more of concerts despite no change in the price of movies
• At point Y the consumer is definitely better off because this combination was not previously available to him
• Indifference curve


  Shows all the various possible combinations of two goods that given an equal amount of utility
• We are not saying how much a consumer likes pears and oranges, merely that he likes all the combinations along the indifference curve the same amount
• Marginal rate of substitution (MRS)


  The slope of the indifference curve, the rate at which the consumer is willing to substitute one good for the other
• As we move down the curve, the marginal rate of substitution diminishes as the slope of the curve gets less
• Characteristics of Indifference Curves

  • We can draw indifference curves. All bundles have a utility level, and we can rank them.
  • We can figure out which indifference curves have higher utility levels and why they slope downward. The "more is better" assumption implies that we can look at a set of indifference curves and figure out which ones represent higher utility levels. The assumption also implies that indifference curves never slope up.
  • Indifference curves never cross.
  • Indifference curves are convex to the origin.
• The marginal rate of substitution is the slope of the indifference curve. It is the rate at which a consumer is willing to substitute one good for another
• Higher indifference curves represent higher utility levels
• Budget line


  Shows the maximum affordable combination of products that a consumer can afford
• Slope of the budget line


  Depends on the relative prices of the products
• The optimum consumption point for the consumer is where the budget line touches - is 'tangential to' the highest possible indifference curve