Chapter 2 - Consumer Preferences

Chapter 2 - Consumer Preferences - Chapter 2 Consumers...

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Unformatted text preview: Chapter 2 Consumers Consumer theory begins with the assumption that consumers are “ratio- nal.” Broadly speaking, this means that consumers make decisions that give them the highest level of satisfaction given the possibilities available to the consumer. As a practical matter this means that we can write down a mathematical function describing the consumer’s satisfaction, which the consumer is then assumed to maximize given some constraints on what he or she can afford. The function mathematically describing the consumer’s satisfaction is called a utility Function . This conception of consumer behavior might raise some questions, such as: Why is this construction of the consumer’s problem necessary? Or: what is gained by describing consumer behavior in this way? You may even doubt that this is how consumers actually make decisions. These are all legitimate concerns, and to try to address some of them, I will adopt the following plan of attack. First, we will describe the construction of the theory, and then the sorts of things that we learn from constructing utility theory in this way. Then, we shall briefly discuss some of the broader philosophical issues underlying the whole exercise. For some partial answers, it is useful to consider why utility theory was developed to begin with. The first attempt at developing a rigorous utility theory is usually attributed to Jules Dupuit, a French Civil Engineer, who performed his work on economics in the 1840’s. He was primarily interested 43 44 CHAPTER 2. CONSUMERS in describing how valuable public works were - that is, how can one describe the value created by society. His insight was that, by constructing a theory of demand based upon a theory of satisfaction - utility theory - one could actually infer something about the value consumers realized when consuming a good. This was the beginnings of the notion of consumers’ surplus, which we shall see is a fundamental tool in economic analysis. The development of a complete formal apparatus employing a utility function first appears in the work of William Stanley Jevons. [More to be written]...The simple idea, which we will render fairly complex, is that, if someone paid 5$ for an object, then they must attach a psychological value to this object of something more than 5$. 2.1 Utility Functions Suppose that we have some list of goods available to the consumer, numbered 1 , 2 , 3 ,...,n . Denote actual consumption levels of each of these goods as x 1 ,x 2 ,x 3 ,...,x n . A utility function takes consumption levels and produces some measure of the total amount of satisfaction the consumer earns. That is: Total Satisfaction = u = u ( x 1 ,x 2 ,x 3 ,...,x n ) (2.1) It is nice to write this down, but for concept embodied in the function defined in (2.1) to be of any use, assumptions must be made that render the concept analytically tractable. The first assumptions are technical in that we make them only so that we can graph utility functions and, eventually,...
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This note was uploaded on 11/13/2009 for the course ECONOMICS 721 taught by Professor Partha during the Fall '09 term at CUNY Hunter.

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Chapter 2 - Consumer Preferences - Chapter 2 Consumers...

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