Utility and Optimising Consumption

• what is utility?

  satisfaction
• what is constrained choice?

  having to sacrifice consumption of one good to consume another
• what do firms/individuals do with opportunity cost?

  minimise it
• what does an indifference curve show?

  -The different combinations of two goods that give a consumer equal satisfaction or utility.

  - illustrates the opportunity cost that any consumer is willing to make between 2 goods x and y
• what is shown at all points on an indifference curve?

  equal utility
• Draw an indifference curve

  
• why is an indifference curve downward sloping?

  some of good y must be sacrificed to consume more of good x (vice versa)
• why are indifference curves convex to the origin?

  diminishing marginal rate of substitution - the amount of good y that must be sacrificed to consume more of good x is not constant along the curve
• why do consumers want to be on highest possible utility curve?

  it represents the greatest utility
• what are some properties of indifference curves?

  - downward sloping

  - convex to origin

  - can't cross (transivity)
• How is utility expressed?

  U = f (x,y) where u is some function of the consumption of x and y
• What is a giffen good?

  -a giffen good is an inferior good for which the negative income effect outweights the positive substitution effect when price falls

  -theoretical and would have an upward sloping demand curve

  - not many subs
• What is opportunity cost?

  cost of sacrificing something for an alternative when choice is constrained
• What is the slope of the indifference curve determined by?

  willingness of consumer to give up units of x to consume more of y (vice versa)
• What is marginal rate of substitution?

  the rate at which an individual is willing to sacrifice consumption of one good for another
• why does the marginal rate of substitution between the slope change on an indifference curve?

  -trade off between x and y varies

  - each additional unit of 1 product requires compensation ( more units of other product to maintain a constant utility)
• What is diminishing marginal utility?

  as consumption increases the marginal utility from each additional unit declines
• What is marginal utility?

  additional satisfaction/ benefit that a consumer gets from consuming an additional unit of a good or service
• the greater the consumption of goods ...

  ... lower the marginal utility derived
• what is a perfect sub?

  - traded like for like

  - makes the indifference curve a straight line because the rate of exchange remains constant
• draw diagram of perfect sub indifference curve ...
• what is a perfect complement ?

  -consumed in strict proportion to each other so that additional units of one good without the other do not increase consumer utility (left + right shoe)

  - rectangular curve since 2 goods are consumed in proportion
• Draw a perfect complement indifference curve ...
• What is optimal consumption?

  where slope of budget line (-px/py) is equal to slope of indifference curve
• What increases utility?

  income
• When is consumption of normal goods greater?

  at higher levels of income
• What is a normal good?

  a good that consumers demand more of when their incomes increase

  - food

  - clothing

  -household appliances
• what is an inferior good?

  goods that consumers demand less of when their incomes rise

  - instant noodles
• how do you show how consumption of normal goods change with income?

  on an engel curve ( as income Y increases, consumption of x increases - x must be a normal good)
• show the engel curve for an inferior good ...
• what is a veblen good?

  goods which are viewed as high quality, luxury and exclusive