Some simplifying assumptions Consumers objective to maximize hisher utility

# Some simplifying assumptions consumers objective to

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Some simplifying assumptions Consumer’s objective: to maximize his/her utility subject to income constraint 2 goods (X, Y) Prices Px, Py are fixed Consumer’s income (I) is given
Consumer Equilibrium Marginal utility per price additional utility derived from spending the next price on the good MU per last dollar = MU P
Consumer Equilibrium Optimizing condition: If spend more on good X and less of Y X Y X Y MU MU P P X Y X Y MU MU P P
Numerical Illustration Q x TU X MU X MUx Px Q Y TU Y MU Y MUy Py 1 30 30 15 1 50 50 5 2 39 9 4.5 2 105 55 5.5 3 45 6 3 3 148 43 4.3 4 50 5 2.5 4 178 30 3 5 54 4 2 5 198 20 2 6 56 2 1 6 213 15 1.5
Simple Illustration Suppose: X = fishball Y = fishcake Assume: P X = 2 P Y = 10
Cont. 2 potential optimum positions Combination A: X = 3 and Y = 4 TU = TU X + TU Y = 45 + 178 = 223 Combination B: X = 5 and Y = 5 TU = TU X + TU Y = 54 + 198 = 252
Cont. Presence of 2 potential equilibrium positions suggests that we need to consider income. To do so let us examine how much each consumer spends for each combination. Expenditure per combination Total expenditure = P X X + P Y Y Combination A: 3(2) + 4(10) = 46 Combination B: 5(2) + 5(10) = 60
Cont. Scenarios: If consumer’s income = 46, then the optimum is given by combination A. .… Combination B is not affordable If the consumer’s income = 60, then the optimum is given by Combination B….Combination A is affordable but it yields a lower level of utility
The Ordinal Approach Economists following the lead of Hicks, believe that utility is measurable in an ordinal sense--the utility derived from consuming a good, such as X, is a function of the quantities of X and Y consumed by a consumer. U = f ( X, Y )
Cont. Ordinal Utility Theory (TUO) Can be measured in qualitative, not quantitative, but only lists the main options (indifference curves & budget line).

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