Lecture4

# Lecture4 - LECTURE 4 Consumer Behaviour Cardinal Utility...

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LECTURE 4: Consumer Behaviour: Cardinal Utility Theory We will consider two theories of demand (cardinal utility theory and indifference curve theory). Both of these theories are built on the assumption that consumers act in their own best interests so as to maximize their Total Utility (TU). P Both theories suggest that at P 1 a consumer “reports” the quantity Q as the quantity that P 1 pq y 1 qy maximizes their total utility at that price. P 2 If prices were to fall to P 2 the consumer no longer maximizes their total utility at Q 1 , but “reports” the Q Q 1 Q 2 quantity Q 2 as the quantity that maximizes their total utility at that price. This process is repeated for every possible price, mapping out the individual’s demand curve for the good. P P 1 We can now think of a consumer’s demand curve as a locus of (equilibrium) points, in price-quantity pace that maximizes the consumer’s total utility Q Q 1 P 2 Q 2 d space, that maximizes the consumer s total utility (TU).

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Assumptions for Cardinal Utility Theory i) Rationality – consumers have the goal of maximizing their total utility subject to certain constraints (like their wealth, for example). ii) Cardinality – TU is measurable in numerical terms. For example, a consumer can )y p, tell if he or she derives twice as much pleasure (utility) from a new quantity consumed of a good compared to the old quantity consumed of the good. TU is sometimes measured in monetary terms. ) Function of all goods consumed U = X iii) Function of all goods consumed – TU = f (X 1 , X 2 , …, X n ) TU is a function of utility derived from all of the goods in the consumer’s consumption bundle. This function could be linear, quasi-linear, quadratic, etc. We make no assumptions regarding the functional form (for now). pg g () A iv) TU varies directly with quantity consumed up to some point of satiation. TU X Rational consumers would not consume beyond point A, since at quantities beyond point A the consumer’s TU is falling. As a sult we often don’t consider the TU X result, we often don t consider the downward sloping portion of the TU curve. X X* Range where X TU
Assumptions for Cardinal Utility Theory (continued) v) Diminishing Marginal Utility – as quantity consumed increases, the increase in TU from the last unit consumed of good X (marginal utility of good X, MU X ) decreases until the satiation point is reached where another unit consumed of good X will not add nything to the consumers happiness (MU 0) anything to the consumers happiness (MU X = 0). We should notice that the marginal utility of good X, MU X , is simply the slope of the Total Utility curve for good X. U U slope of TU urve MU X = TU X = slope of TU X curve X Notice that the slope of TU X becomes flatter as we move along the curve until, at point A, the slope is flat and MU X = 0.

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Lecture4 - LECTURE 4 Consumer Behaviour Cardinal Utility...

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