The theory of consumer demand Flashcards
What is the difference between the cardinal and ordinal approach?
The cardinal approach states that cardinal numbers can be used to measure a consumer satisfaction. However, the ordinal approach states that consumers can rank goods in order of preference and say that they derive more utility from one good than another.
What is the difference between total utility and marginal utility?
Total utility is the total satisfaction a consumer gets from the consumption of all the units of a good consumed within a given time period. While marginal utility is the satisfaction a consumer derivers from consuming an extra unit of a commodity.
State the law of diminishing marginal utility
States that as the quantity of goods consumed by an individual increase. The marginal utility of the good will eventually decrease.
What are the assumption underlying utility theory
- Consumers are rational i.e. the consumer aims to maximize his or her total utility within the decision constraints faced.
- It is assumed that utility is countable in measurable. The most prominent equivalent to utility is money.
- Constant marginal utility of money.
- Diminishing marginal utility i.e. the utility derived from each successive unit of a commodity consumed falls continually.
- The total utility derived from a given basket of goods is equal to the sum of the utility derived from each commodity.
What is the marginal utility formula?
MU= change in total utility/ change in marginal utility
What happens when marginal utility is at zero?
Total utility is at its maximum
What is utility
A representation of satisfaction that individuals derive from consuming goods and services
NB: Utility is inherently subjective, meaning it varies from person to person based on preferences, tastes, and circumstances.
What is an indifference curve?
A curve which joins all the different combinations of two goods which yield the same utility to the consumer.
What are some characteristics of the indifference curve?
-Indifference curves slopes downward from left to right
-Indifference curves NEVER intersect
-Indifference curves are convex to the origin
-The further away the IC is from the origin, the higher the level of satisfaction
Define the marginal rate of substitution
This measures the rate you are willing to forgo the quantity of one good to have more of an other while keeping the level of satisfaction the same.
What is a budget line?
A budget line represents the combinations of two goods that a consumer can purchase given their income and the prices of those goods. It shows the consumer’s spending constraint, reflecting what they can afford to buy at current prices with their available budget.
Define the slope of the budget line
The slope of the budget line represents the rate at which a consumer can trade one good for another while staying within their budget.
What does it mean when the budget line intercepts an axis?
The budget line intersects the axes where the consumer spends all their income on only one of the goods.
If the consumer spends all their income on good X, the quantity of good X they can buy is?
I/Px
(I= Income
P= Price
x= Good x
What is the equation for a budget line?
(Px ⋅X) + (Py ⋅Y) = I
where X and Y are the quantities of the two goods, Px and Py are their prices, and I is the consumer’s income.
What is optimal consumption?
The point where an indifference curve is tangent to the budget line represents the consumer’s optimal consumption bundle, where the consumer maximizes utility.
