Chapter%207 - Econ 160, Vardanyan Chapter 7 Consumer Choice...

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Econ 160, Vardanyan 1 Chapter 7 Consumer Choice Using Utility Theory Consumer choice is modeled via the theory of consumer behavior that is based on the notion that the consumers do best they can given the limitations dictated by their incomes and prices of goods and services. The question that a rational consumer is asking is the following: given my limited income and the prices of goods I would like to buy, what is the best way I can spend this income, i.e. which bundle of goods will maximize my satisfaction? The Concept of Utility Utility is defined as the satisfaction experienced from consuming the good . Utility is hard to measure, as no units of measurement exist. However, to be able to quantify our analysis, we will assume that we can measure using utils , i.e. a util is the measure of a one unit of utility. The marginal utility is defined as the change in total utility resulting from an increase in consumption by one additional unit of a good or a service (Fig. 7.1, panel B). We assume that the marginal utility is decreasing, because of the law of diminishing marginal utility – as the consumption of a particular good increases, marginal utility decreases . Consumer Constraints and Preferences Let’s follow the example in the book. Suppose that Maxine has a fixed monthly income and that she spends all of it on only two goods – movies and books. Because Maxine tries to maximize her satisfaction, i.e. consume as many books and movies as possible, she’s interested in answering the following two questions: What are the alternative combinations of books and movies that my income can purchase? Of these various options, which one is the best, i.e. the satisfaction- maximizing one? To answer the firs question we define the budget line. The budget line is the line connecting all the combinations of two goods that exhaust a consumer’s budget . For example, if Maxine’s income is $30, the price of a movie is $3 and the price of a book is $1 then the budget line is the line given in Fig. 7.2 (or 7A.1 in the Appendix). At point
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Chapter%207 - Econ 160, Vardanyan Chapter 7 Consumer Choice...

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