Fundamentals of Economic Theory Lecture 3 Theory of

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Fundamentals of Economic Theory Lecture 3. Theory of consumer choice. Production and the marginal

Fundamentals of Economic Theory Lecture 3. Theory of consumer choice. Production and the marginal product. Yevgeniy M. Orel, C. Sc. (Econ. ), Docent, Faculty of Economic Science, Na. UKMA

Topic 3 a Theory of consumer choice 10/2/2020 2

Topic 3 a Theory of consumer choice 10/2/2020 2

Outline of the presentation (Topic 3 a) • • Total and marginal utilities (TU

Outline of the presentation (Topic 3 a) • • Total and marginal utilities (TU & MU) The law of diminishing marginal utility Determinants of consumer choice The rule of utility maximization Marginal utility and the demand curve’s down-sloping Budget restraint and the indifference curve Consumer’s point of equilibrium and the demand curve 10/2/2020 3

Total and marginal utilities [1] • UTILITY (корисність) – “The pleasure or satisfaction derived

Total and marginal utilities [1] • UTILITY (корисність) – “The pleasure or satisfaction derived by an individual from being in a particular situation or from consuming goods or services. ” 10/2/2020 4

Can utility be measured? • Cardinal (absolute) utility? • Ordinal (relative) utility? 10/2/2020 5

Can utility be measured? • Cardinal (absolute) utility? • Ordinal (relative) utility? 10/2/2020 5

Use versus utility • • Apples and oranges? Candies and ice-cream? Sad movies and

Use versus utility • • Apples and oranges? Candies and ice-cream? Sad movies and soap operas? Cigarettes and narcotic drugs? 10/2/2020 6

Total and marginal utilities [2] • TOTAL UTILITY (загальна корисність) – “…total amount of

Total and marginal utilities [2] • TOTAL UTILITY (загальна корисність) – “…total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service. ” (C. Mc. Connell, S. Brue) 10/2/2020 7

Total and marginal utilities [3] • MARGINAL UTILITY (гранична корисність) – “…the extra satisfaction

Total and marginal utilities [3] • MARGINAL UTILITY (гранична корисність) – “…the extra satisfaction a consumer realizes from an additional unit of a product. ” (C. Mc. Connell, S. Brue) • MARGINAL UTILITY – “…the change in total utility resulting from the consumption of one more unit of a product. ” (C. Mc. Connell, S. Brue) 10/2/2020 8

Total and marginal utilities [4] MUn =TUn –TUn-1 n – number of consumed goods/services

Total and marginal utilities [4] MUn =TUn –TUn-1 n – number of consumed goods/services MU – marginal utility (гранична корисність) TU – total utility (загальна корисність) 10/2/2020 9

The law of diminishing marginal utility* • Each extra unit of a commodity consumed

The law of diminishing marginal utility* • Each extra unit of a commodity consumed lets consumer gain less satisfaction that the previous one. • Every extra unit of a good or service consumed within a relatively short period of time brings less utility than the previous one: MUn < MUn-1 *Ukr: Закон спадної граничної корисності 10/2/2020 10

The law of diminishing marginal utility “in action” Chocolate bars consumed by a student

The law of diminishing marginal utility “in action” Chocolate bars consumed by a student during an break between classes 1 st bar 2 nd bar 3 rd bar 4 th bar 10/2/2020 Marginal utility (utils) Total utility (utils) 6 3 1 -2 6 9 10 8 11

Determinants of consumer choice • • Rational behavior Tastes and preferences Budget constraints Prices

Determinants of consumer choice • • Rational behavior Tastes and preferences Budget constraints Prices 10/2/2020 12

The rule of utility maximization • The total utility will be the greatest possible

The rule of utility maximization • The total utility will be the greatest possible if each hryvnia spent on the last item of each good or service brings the consumer equal utilities: MU 1/P 1 = MU 2/P 2 = … = MUn/Pn 10/2/2020 13

Marginal utility and the demand curve’s down-sloping • The lower the price, the lower

Marginal utility and the demand curve’s down-sloping • The lower the price, the lower the utility that can offset the consumer’s expenditures, and thus the greater the quantity of goods he consumer will buy. 10/2/2020 14

Budget restraint and the indifference curve • Budget restraint line is a straight line.

Budget restraint and the indifference curve • Budget restraint line is a straight line. • Indifference curve is a curve because of the law of diminishing marginal utility. 10/2/2020 15

Consumer’s point of equilibrium and the demand curve • Consumer’s equilibrium is reached in

Consumer’s point of equilibrium and the demand curve • Consumer’s equilibrium is reached in the point of tangency between the budget restraint line and an indifference curve. 10/2/2020 16

Topic 3 b Production and the marginal product 10/2/2020 17

Topic 3 b Production and the marginal product 10/2/2020 17

Outline of the presentation (Topic 3 b) • • Production function Total, average and

Outline of the presentation (Topic 3 b) • • Production function Total, average and marginal products The law of diminishing marginal productivity Isoquants Leontieff’s production function Neoclassical production function The marginal rate of substitution 10/2/2020 18

Production function • Production function (виробнича функція) equation (a mathematical expression ) that reveals

Production function • Production function (виробнича функція) equation (a mathematical expression ) that reveals relationship between output and inputs needed to create that output. 10/2/2020 19

Total, average and marginal products • Total product (загальний продукт) is the total output

Total, average and marginal products • Total product (загальний продукт) is the total output produced with a combination of certain quantities of inputs. • Average product (середній продукт) is the total output divided by the quantity of the input. • Marginal product (граничний продукт) is the output produced as a result of applying an incremental unit of input. 10/2/2020 20

The law of diminishing marginal productivity • After some point, the more of a

The law of diminishing marginal productivity • After some point, the more of a variable input is added to a certain fixed input, the lesser the additional output will be obtained. 10/2/2020 21

Isoquants • Isoquant, isoquant curve, (ізокванта) is a curve representing different combinations of factors

Isoquants • Isoquant, isoquant curve, (ізокванта) is a curve representing different combinations of factors (inputs) resulting in the same amounts of output. 10/2/2020 22

Neoclassical production function 10/2/2020 23

Neoclassical production function 10/2/2020 23

Leontief’s production function 10/2/2020 24

Leontief’s production function 10/2/2020 24

Wassily Leontief, 1906 -1999 10/2/2020 25

Wassily Leontief, 1906 -1999 10/2/2020 25

Marginal rate of substitution [1] • Marginal rate of technological substitution (MRTS) (граничний коефіцієнт

Marginal rate of substitution [1] • Marginal rate of technological substitution (MRTS) (граничний коефіцієнт технологічного заміщення) is a ratio of a unit of one input (A) we add to the amount of another input (B) we give up for the sake of using the unit of the input A, the output remains the same. 10/2/2020 26

Marginal rate of substitution [2] • Graphically, MRTS determines the slope of the isoquant.

Marginal rate of substitution [2] • Graphically, MRTS determines the slope of the isoquant. • Replacing one input with another means movement from one point of the isoquant to another, provided the output remains the same. • Changes in output result in shifting to another isoquant. 10/2/2020 27

Дякую за увагу! Thank you for attention! 10/2/2020 28

Дякую за увагу! Thank you for attention! 10/2/2020 28