Professor C.L. Ballard
Fall Semester, 2007
KEY CONCEPTS FROM THE MIDDLE PART OF THE COURSE
I. Consumer Behavior
A. We define marginal utility
as the additional utility derived from consuming one more unit of any good.
When utility is measured in dollars of willingness to pay, marginal utility is the extra amount of money that
the individual is willing to pay, in order to consume one additional unit. We assume that consumers have
diminishing marginal utility
, which means that their marginal utility will decrease when their consumption of
a good increases.
B. We assume that the individual consumer is too small to affect the market price. Therefore, the
individual consumer takes price as given. The consumer will maximize satisfaction by choosing the
quantity at which marginal utility is equal to price for every commodity. In this case, the individual
is given by the marginal utility curve.
C. Individual demand curves are summed horizontally to get market demand curves
D. Consumer surplus
is the excess of willingness to pay over the amount actually paid. Graphically, this
is the area under the demand curve but above the price line. If price rises (for example, because of a
leftward shift in the supply curve, or because of a government price control), consumer surplus will
decrease. If price falls, consumer surplus will increase. The change in consumer surplus is our dollar
measure of the harm to consumers from a price increase, or the benefit to consumers from a price
II. Production, Cost, and Profit Maximization
A. As the level of output changes, fixed inputs
remain the same. Fixed costs
are the costs associated
with fixed inputs. Thus, the total amount of fixed cost is constant, regardless of the level of output. In
particular, the firm’s fixed costs are the same when output is zero as when any positive amount of
output is produced. Variable inputs
are the inputs that must be increased, in order to increase the level
of output. Variable costs
are the costs associated with variable inputs. The short run
is a period of time
that is short enough that at least one input is fixed. In the long run
, all inputs are variable.
B. The law of diminishing returns
or the law of diminishing marginal product
states that, if we increase
one variable input while holding all other inputs constant, the additional increases in output will
eventually get smaller.
C. Total cost is equal to the sum of total fixed cost and total variable cost: TC = TFC + TVC.
D. Average variable cost (
., variable cost per unit) is equal to total variable cost divided by the
quantity of output: AVC = TVC/Q. Average fixed cost (
., fixed cost per unit) is equal to total fixed
cost divided by the quantity of output: AFC = TFC/Q. Average fixed costs always decrease as the