week 3 : consumer theory

Question 1

What is a rational consumer ?

Answer 1

person whose purchasing decisions (how much to consume at what price?) is driven by a calculation of costs and benefits

Question 2

What is total utility ?

Answer 2

a measure for the total satisfaction a person receives/feels/derives from consuming a good within a specific time period (measured in ‘utils’)

Question 3

What is marginal utility ?

Answer 3

the additional satisfaction a person gains from consuming one extra unit of a good within a specific time period

Question 4

What is diminishing marginal utility ?

Answer 4

with every additional unit of consumption, the extra satisfaction a person experiences decreases

Question 5

How do you calculate marginal utility ?

Answer 5

Marginal utility for a given quantity is simply calculated as the slope of total utility at that quantity With respect to points a and b we’ll have:

MUb = ∆TU ∆Q = TUb − TUa Qb − Qa = 13 − 11 3 − 2 = 2

Answer 6

The more a consumer is willing to pay, the higher their satisfaction derived from consumption

The market demand curve for a good can be calculated by summing up individual MU curves

• The price elasticity of demand will be equal to the slope this MU curve
• Shifts in the demand curve as the result of income and changes in the price of other goods shift the TU curve and therefore the MU curve

Question 7

What is indifference analysis ?

Answer 7

Completeness: the individual has a clear preference whenever they need to make a choice: - they choose A over B

Transitivity: if an individual prefers A over B and B over C then they must also prefer A over C

Consistency: Preferences don’t change

The indifference curve shows all the combinations between two goods for which the consumer is indifferent because each combination on the curve achieves the same level of satisfaction

Question 8

What is the slope of indifference ?

Answer 8

The slope of the indifference curve gives us the rate at which a consumer is willing to exchange one good for the other while keeping their level of satisfaction constant

• E.g. from point a to b is willing to give up 6 units of pears in exchange for 1 unit of apples MRS = ∆Y ∆X = −6/1 = −6 - This is called the Marginal Rate of Substitution

As we move along the curve, the slope decreases
This decreasing slope is also referred to as diminishing marginal rate of substitution -

For this example: the higher the consumption of oranges, the lower the amount of pears the consumer is willing to exchange for an additional orange