Consumer Choice Theory Principles of Microeconomics 2023 Boris

Consumer Choice Theory Principles of Microeconomics 2023 Boris Nikolaev

Utility Analysis Utility = happiness (satisfaction from consumption) 1. subjective. 2. hard to measure. 3. preferences are stable.

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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 Model Two goods: X, Y px = price of x px =price of y The budget constraint How much X, Y should you consume? U =f(X, Y) utility function

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

Preferences We 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 Minimum amount of good y you would accept in a trade for one unit of good x MRS = - slope of ind. curve

The Tangency Condition The slope of the indifference curve = - MRS = - Px/Py the tangency condition

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.