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# Term1 - 1 Utility Theory September-09-09 6:37 PM Advice 1...

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Advice 1: Fight H1N1 in teams of buddies 1 ECONOMICS 200 Lecture Assignment #1 Consumer Choice: Utility Theory Source: BB, Chapter 3 to page 77. Approach in Lecture differs from text in some aspects. Also BB, Chapter 5, pages 159-160. Note: You should bring a copy of the relevant Lecture Assignment(s) to class, as a guide to the outline of the lecture. Some students take lecture notes directly on the LA document. If you choose to do this, you might want to create more “white space” to provide room for notes. Alternatively, some students take notes separately. You should find a note-taking methodology that works best for you. One of the challenges in lectures is to avoid mere copying without expending any intellectual effort to understand the contents. Background Suppose utility / satisfaction is measurable in units of "jollies" (i.e. there is a "cardinal utility" function). We assume that the consumer is able to buy the equilibrium quantities that maximize satisfaction. (In other words, we are ignoring the “income constraint” for now.) 1. One-Good Utility Function Sammy Student's Total Utility Function follows (for a given period of time): TU(X) = 12X X^ 2 (measured in “jollies”) [Sometimes written as U(X)]. 1.1 Define the concept of Marginal Utility of X i.e., MUX. Now calculate the equation for MUX. 1.2 Develop the MU schedule in a table and then graph MU (with quantity on the horizontal axis). 1.3 What is the meaning of the downward slope of MU? Is this reasonable? 1.4 If X is free, how much will be consumed? Put another way, what is the value of X that maximizes the TU(X) equation? Consumer Theory under certainty Satisfaction is measurable "Cardinal" measurement Jollies = units of satisfcation Utility Theory 1. Rating system (no value at all) "Ordinal" measurement Indifference Theory 2. Revealed Preference Theory (later) 3. One Good Utility Theory Note: budget = limitations TU(x) = U(x) Marginal Utility of x = MUx Law of Diminishing MU *** Case above: Assuming MU of money is constant And MU of item is decreasing 1 - Utility Theory September-09-09 6:37 PM Term 1 Page 1

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3. One-Good Utility Theory: Two Problems 3.1 The “Price Club” offers shoppers the opportunity to buy “stuff” (S) in a large warehouse with lots of parking. The Demand Schedule for “stuff” of a typical consumer is P = 100 2S . The typical consumer buys 25 units of “stuff”. What is the maximum fee to join the Club that could be charged? Use a demand-supply diagram. 2. Consumer Surplus (Source: BB, Chapter 5, pages 159 -160; skip reference for now about the “income effect”, to be discussed later in the course.) 2.1 Define Consumer Surplus. 2.2 Using the information from Question 1 above (with MUM = 1), calculate the value of Consumer Surplus when the quantity consumed is 5 units.
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