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Principles of Microeconomics(Microeconomics, by: Karlan/Morduch)Chapter 07: Consumer BehaviorAppendix E: Indifference curvesHossein A. AbbasiUniversity of Maryland, College Park
What will you learn in this chapter?Consumer theory: maximizing utility subject to budget constraints.How revealed preferences relate to utility.How budget constraints affect utility maximization.How income affects consumption choices.How prices affect consumption choices and how to distinguish between income and substitution effects.How utility is influenced by outside perceptions, and how people get utility from altruism and reciprocity.
7-3Utilityis a measure of the amount of satisfaction a person derives from something.◦Incorporates emotions and sensations.◦Universal measure (or yardstick) that allows individuals to compare choices.◦Not typically comparable across individuals.Rational individuals maximize utility when making choices.Utility basics
7-4Utility is hard to measure.How can anything meaningful be said about the utility people experience?◦Observe what people actually do.The principle of revealed preference is that people’s preferences can be determined by observing their choices and behavior.The principle of revealed preferences isn’t feasible for analyzing how people make choices.Revealed preferences
7-5Utility functions aid in systematically analyzing choices.◦A utility function is a formula for calculating the total utility that a particular person derives from consuming a combination of goods and services (called a bundleof commodity).Utility functions
7-6Utility functions quantify preferences.Utility measurements are relative, not absolute.For example, suppose Sarah receives a utility of 3 for each serving of mac-n-cheese she eats, 2 for broccoli, and 8 for ice cream.If she eats 1 serving of mac-n-cheese, 2 servings of broccoli, and 2 of ice cream, then:total utility = (3 x 1) + (2 x 2) + (8 x 2) = 23Utility functions
7-7From chapter 1: consumers make decisions based on marginal cost and marginal benefit (marginal utility). When individuals continue to engage in an activity or consume more of one good or service, the utility from the next unit is not as great as the last unit.◦Marginal utilityis the change in total utility from consuming an additional unit of a good or service.Marginal utility
7-8The principle of diminishing marginal utility is that the additional utility gained from consuming successive units of a good or service tends to be smaller than the utility gained from the previous unit or service.Sometimes, marginal utility becomes negative (when you get sick).It is possible that in the real world the marginal utility stays the same or even increases after the first one, but it eventually decreases.