Consumer Equilibrium in Economics

Chapter Three: Theory of Consumer Behavior

• Consumers buy goods and services to derive satisfaction.
• Consumer theory examines preferences, which are not directly measurable, inferring them from choices.
• Consumer behavior is best understood in three steps: preferences, budget constraints, and choice.

Consumer Preferences

• Consumers compare bundles of goods, classifying them as strictly preferred, indifferent, or weakly preferred.
• The symbol ">" means strictly preferred, meaning one bundle is better than another.
• The symbol "~" means indifferent, meaning both bundles give the same satisfaction.

Utility

• Utility is the satisfaction derived from consuming a good or service.
• Utility and usefulness are not synonymous; usefulness is product-centric, while utility is consumer-centric.
• Utility is subjective and varies across individuals and over time; one person may feel more satisfaction from something than another.
• Utility is not quantifiable; consumers can rank choices but cannot put a number on a degree of satisfaction.

Cardinal Utility Theory

• This theory assumes utility is measurable in quantifiable units called "utils," allowing for comparison of satisfaction levels.
• Consumers aim to maximize satisfaction given their budget constraints.
• Constant marginal utility of money assumes that a unit of money retains the same value at any time.
• Diminishing marginal utility (DMU) means each additional unit of a good yields less satisfaction than the previous one.

Total and Marginal Utility

• Total Utility (TU) is the total satisfaction from consuming a given quantity of a good.
• Marginal Utility (MU) is the extra satisfaction from consuming one more unit of a good.
• TU increases to a maximum and then decreases as consumption increases.
• MU decreases as consumption increases.

Law of Diminishing Marginal Utility

• As the consumption of a good increases, the marginal utility derived from each additional unit decreases, holding all other factors constant.

Ordinal Utility Theory

• This theory rejects the concept of measurable utility but focuses on the ranking of preferences.
• Consumers can rank bundles of goods but cannot quantify their utility.
• Indifference curves represent the combinations of goods that yield the same level of satisfaction for a consumer.
• Higher indifference curves represent higher levels of satisfaction.

Indifference Curves

• Indifference curves slope downward, are convex to the origin, and do not intersect.
• The slope of an indifference curve reflects the marginal rate of substitution (MRS).
• MRS shows the rate at which one good can be substituted for another while maintaining the same level of satisfaction.

Budget Line

• The budget line shows the various combinations of goods that a consumer can purchase with a given income and prices.
• The slope of the budget line is the negative of the ratio of the prices of the two goods.
• Changes in income or prices will shift the budget line.

Consumer Equilibrium

• Consumer equilibrium occurs at the point where the budget line is tangent to the highest attainable indifference curve.
• At equilibrium, the marginal rate of substitution (MRS) is equal to the price ratio (P_x/P_y).
• This tangency point identifies the optimal bundle of goods that maximizes the consumer's satisfaction given their budget constraint.

Chapter Four: Theory of Production and Cost

• This chapter explores production functions, classifying inputs (fixed and variable), essential features of short-run and long-run production, and cost functions.
• Production is the process of transforming inputs into outputs (goods or services).
• Production function shows the relationship between inputs and outputs.

Production Function

• Production function expresses the relationship between inputs and outputs.
• The output is a function of inputs (inputs are the factors of production)
• A general equation for the production function is Q=f(K,L,...), where Q is output, and K, L, ... are inputs (capital, labour and other inputs like raw materials)

Total, Average, and Marginal Product

• Total Product (TP) is the total amount of output produced.
• Average Product (AP) is the total output divided by the quantity of a variable input.
• Marginal Product (MP) is the change in total product attributable to a one-unit increase in a variable input, holding all other inputs constant

Stages of Production

• Stage I: Increasing returns to the variable input, MP is rising and AP is rising.

• Stage II: Diminishing returns to the variable input. MP is falling, but still positive, AP is falling.

• Stage III: Negative returns to the variable input. MP is negative, AP is negative,

• The law of variable proportions explains that the marginal product of a variable input eventually declines as more of it is used with fixed inputs. This is due to diminishing returns.