Consumer Choice Theory Principles of Microeconomics 2023 Boris Nikolaev

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Consumer Choice Theory Principles of Microeconomics 2023 Boris Nikolaev. Utility Analysis. Utility = happiness (satisfaction from consumption) subjective. hard to measure. preferences are stable. mmm …. The Law of Diminishing Marginal Utility.

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Consumer Choice TheoryPrinciples of Microeconomics 2023Boris Nikolaev

Utility Analysis

Utility = happiness (satisfaction from consumption)

subjective.

hard to measure.

preferences are stable.

The Law of Diminishing Marginal Utility

Marginal Utility: utility from consuming one more unit of the good.

Total Utility: utility from consumption so far.

The Model

Two goods: X, Y px = price of x px =price of y

How much X, Y should you consume?

U =f(X,Y) utility function

The budget constraint

Assumptions
• Perfect Information
• “More is better”
• Perfectly rational  maximizing utility
Master’s level explanation
• How we use calculus to solve this problem.
Preferences

We use indifference curves to measure preferences.

= all combinations of x, y that makes you equally happy.

Properties of indifference curves
• As you consume more (go NE) you become happier.
• There are infinitely many indifference curves (they never intersect).
• Downward sloping (convex shape)
Marginal Rate of Substitution

Minimum amount of good y you would accept in a trade for one unit of good x

MRS = - slope of ind. curve

The Tangency Condition

The slope of the indifference curve = - MRS = - Px/Py

the tangency condition

Economic Efficiency
• Pareto Superior: change in allocation of resources is PS if we can make somebody better off without making somebody worse off.
• Pareto Optimal: an allocation is PO if no one could be made better off without making somebody else worse off.