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CHAP 7 &amp; 8 - CONSUMER THEORY - Utility and demand &amp; Possibilites, preferences and choices

# CHAP 7 & 8 - CONSUMER THEORY - Utility and demand & Possibilites, preferences and choices

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CONSUMER THEORY 1 CONSUMER THEORY 1 CHAP 7: CHAP 7: Utility and Demand Utility and Demand Olivier Giovannoni 304K: Introduction to Microeconomics CHAP 6 & 7 slide # 1 Sept 24, 2007

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1- Budget constraints 1- Budget constraints A budget constraint describes the limits to consumption choices given the prices of the goods and the total expenditure. Typically for two goods 1 and 2 we have: The budget constraint is a decreasing line (slope is –p 1 /p 2 ) with y -intercept B/p 1 . It is similar to the PPF, but for the consumer. CHAP 6 & 7 slide # 2 { { { 1 1 2 2 total spent total spent budget on good 1 on good 2 total amount consumed 2 2 1 2 1 2 p q p q B solving for q we get q (p p )q B p + - + 1 442 4 43
1- Budget constraints (cont.) 1- Budget constraints (cont.) CHAP 6 & 7 slide # 3 q 1 q 2 slope = -p 1 /p 2 This is called the relative price of good 1 with respect to good 2 y -intercept = B/p 1 Budget constraint attainable not attainable q 1 q 2 q 1 q 2 Change in budget (or income): change in the intercept Change in (relative) price: change in slope 2 1 2 1 2 q (p p )q B p 1 - +

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2- Preferences and utility maxim. 2- Preferences and utility maxim. How do we decide what goods to consume and in which proportions (which point on the budget line)? we optimize the utility we get from our consumption choices Utility is a unit-free measure of satisfaction. Total utility is the sum of the satisfaction we get from the consumption of good 1 and 2, in a certain proportion. Marginal utility is the change in total utility we get from a one-unit increase in the quantity of one good. The idea is the same as marginal benefit . ( glass of water example) As consumption increases, total utility gets higher but CHAP 6 & 7 slide # 4
2- Preferences and utility maxim. 2- Preferences and utility maxim. So we optimize our utility under the constraint of our budget. This is utility maximization (and reflects scarcity). Positions under the budget line are not optimal because we could consume more hand thus have greater utility Conversely, positions above the budget line are not attainable because of a lack of income The optimizing choice is on the budget line : by consuming all your income you maximize your utility.

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