Economics Chapter: Understanding Utility
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What does 'utility' mean as the 'satisfaction obtained from consuming a commodity or it could also be considered as the ‘Want Satisfying’ power of a commodity.

Utility is defined as the satisfaction we obtain from consuming a commodity or it could be considered as the want-satisfying power of a commodity.

What are the two major classifications of Utility?

  • Cardinal Utility and Ordinal Utility (correct)
  • Direct Utility and Indirect Utility
  • Personal Utility and Market Utility
  • None of the above

Who propagated cardinal utility?

Alfred Marshall

Cardinal utility theory suggests that utility is measurable.

<p>True (A)</p> Signup and view all the answers

According to cardinal utility, what is the unit used to measure utility?

<p>utils</p> Signup and view all the answers

What does the Law of Diminishing Marginal Utility (LDMU) say?

<p>It says that the additional benefit that a consumer derives from an increase in stock of a thing diminishes, other things being equal, with every increase in the stock that he already has.</p> Signup and view all the answers

Ordinal Utility suggests that utility is measurable.

<p>False (B)</p> Signup and view all the answers

What is total utility?

<p>The total satisfaction that a person gets from the consumption of goods and service.</p> Signup and view all the answers

What is average utility?

<p>The average satisfaction that a person gets from the consumption of a unit goods and service.</p> Signup and view all the answers

What is marginal utility?

<p>The addition to the total utility as a result of consuming one additional unit of the same good or service.</p> Signup and view all the answers

The most important assumptions of the Law of Diminishing Marginal Utility are continuous consumption and standard units.

<p>True (A)</p> Signup and view all the answers

What is the exception to the Law of Diminishing Marginal Utility?

<p>Money</p> Signup and view all the answers

An indifference curve represents a combination of two goods which give the same level of satisfaction.

<p>True (A)</p> Signup and view all the answers

What are the assumptions of the indifference curve?

<p>The assumptions are: Rationality, Order/ Rank Preferences, Non-Satiety, Consistency and Transitivity of Choice</p> Signup and view all the answers

What does the Marginal Rate of Substitution (MRS) represent?

<p>The rate at which the consumer is willing to trade one good for another.</p> Signup and view all the answers

What is the main characteristic of a perfect substitute?

<p>The IC for perfect substitute is a straight-line downward sloping.</p> Signup and view all the answers

What is the main characteristic of a perfect complement?

<p>The IC for perfect complement is a L-shaped curve</p> Signup and view all the answers

What does the budget line represent?

<p>The budget line represents the maximum of 2 goods that can be bought with a given level of income.</p> Signup and view all the answers

What happens to the budget line when the money income increases?

<p>The budget line shifts outward parallelly</p> Signup and view all the answers

What happens to the budget line when the price of good x increases?

<p>The budget line will pivot inwards</p> Signup and view all the answers

What are the conditions for consumer equilibrium?

<p>The conditions are: IC should be downward Sloping, IC should be tangent to the budget line, i.e. slope of IC (MRS) = Slope of Budget Line (Price Ratio)</p> Signup and view all the answers

Consumer equilibrium is determined at a pint where MRSxy = Px/Py

<p>True (A)</p> Signup and view all the answers

At which unit of consumption does the Total Utility reach its maximum?

<p>Fifth unit (B)</p> Signup and view all the answers

What is the Marginal Utility at the sixth unit of consumption?

<p>Negative five (B)</p> Signup and view all the answers

Which statement accurately describes the relationship between Total Utility and Marginal Utility?

<p>When MU is zero, TU is not necessarily at its maximum. (C)</p> Signup and view all the answers

Why should a rational consumer stop consumption at the fifth unit?

<p>The Marginal Utility becomes negative. (B)</p> Signup and view all the answers

What does a negative Marginal Utility imply for the consumer?

<p>The consumer may feel unwell or dissatisfied. (A)</p> Signup and view all the answers

What generally happens to Total Utility after the fifth unit of consumption?

<p>It decreases. (B)</p> Signup and view all the answers

What is the primary exception to the Law of Diminishing Marginal Utility?

<p>Money (A)</p> Signup and view all the answers

What can be inferred about consumer behavior when Total Utility is still increasing?

<p>Marginal Utility is positive. (D)</p> Signup and view all the answers

What does the Law of Diminishing Marginal Utility imply about additional units consumed?

<p>Satisfaction from each additional unit decreases. (A)</p> Signup and view all the answers

In the context of utility, what is the formula for Average Utility?

<p>AU = TU/n (A)</p> Signup and view all the answers

How is Marginal Utility defined?

<p>The change in total utility from an additional unit consumed. (A)</p> Signup and view all the answers

What is the primary concern of microeconomics in relation to utility?

<p>The effect of additional consumption on decision-making. (B)</p> Signup and view all the answers

Which statement correctly describes Total Utility?

<p>It is the accumulated satisfaction from consuming all units. (A)</p> Signup and view all the answers

What role does the Indifference Curve analysis play in consumer choice?

<p>It compares different combinations of goods for equal satisfaction. (A)</p> Signup and view all the answers

Which of the following statements about Average Utility is incorrect?

<p>Average Utility increases with increasing consumption. (D)</p> Signup and view all the answers

What happens to Marginal Utility as consumption of a good increases?

<p>Marginal Utility decreases according to the Law of Diminishing Marginal Utility. (C)</p> Signup and view all the answers

What does the assumption of Cardinal Utility imply?

<p>Satisfaction can be assigned a numerical value. (B)</p> Signup and view all the answers

Why is Continuous Consumption a critical assumption in the Law of Diminishing Marginal Utility?

<p>It means that consumption occurs without breaks for effect to be realized. (B)</p> Signup and view all the answers

Which factor does NOT impact the Law of Diminishing Marginal Utility according to its assumptions?

<p>Availability of alternative goods. (B)</p> Signup and view all the answers

How is the assumption of Standard Units important in this context?

<p>It helps measure satisfaction accurately without ambiguity. (B)</p> Signup and view all the answers

What occurs to the Marginal Utility of a good after several units are consumed, based on a typical pattern?

<p>It diminishes after reaching a peak. (B)</p> Signup and view all the answers

Which assumption ensures that a consumer's money remains unchanged?

<p>MU of Money remains constant. (B)</p> Signup and view all the answers

What impact does a change in price have on consumer behavior according to the assumptions?

<p>It affects decisions to consume more or less. (A)</p> Signup and view all the answers

What is implied by the assumption of Quality being Constant?

<p>The product must remain unchanged throughout consumption. (B)</p> Signup and view all the answers

What happens to your satisfaction level when moving along an upward sloping indifference curve?

<p>Satisfaction increases as you gain more of both goods. (B)</p> Signup and view all the answers

Why is an indifference curve convex to the origin?

<p>It reflects the law of diminishing marginal rate of substitution. (D)</p> Signup and view all the answers

What is the main implication of higher indifference curves in terms of satisfaction?

<p>They indicate a higher level of satisfaction due to increased consumption. (A)</p> Signup and view all the answers

What does the intersection of two indifference curves imply?

<p>It violates the law of transitivity. (C)</p> Signup and view all the answers

What characteristic is true for a straight line downward sloping indifference curve?

<p>It denotes constant marginal rate of substitution. (C)</p> Signup and view all the answers

Which statement correctly describes concave indifference curves?

<p>They suggest marginal utility increases as consumption rises. (C)</p> Signup and view all the answers

What does the assumption of non-satiety imply regarding consumer behavior?

<p>Consumers will always seek to increase their level of satisfaction. (D)</p> Signup and view all the answers

What is the condition for the marginal rate of substitution to diminish?

<p>When the indifference curve is convex to the origin. (B)</p> Signup and view all the answers

What happens to the marginal rate of substitution (MRS) as a consumer moves along an indifference curve from one extreme to the other?

<p>It decreases. (B)</p> Signup and view all the answers

Which characteristic of indifference curves ensures that satisfaction remains constant along the curve?

<p>Downward sloping. (A)</p> Signup and view all the answers

Why would a rational consumer prefer to be on a higher indifference curve?

<p>It provides a higher level of utility. (C)</p> Signup and view all the answers

What is observed when moving from point A to point E in the tabulated data for goods X and Y?

<p>The MRS declines. (C)</p> Signup and view all the answers

What does the convex shape of an indifference curve imply about the consumer's preference?

<p>The consumer values goods differently as more of one is consumed. (B)</p> Signup and view all the answers

Which of the following best describes how two indifference curves behave in relation to each other?

<p>No two can intersect each other. (C)</p> Signup and view all the answers

What does a consumer value more when having fewer units of that good?

<p>The good that is scarcer. (C)</p> Signup and view all the answers

What overall trend is observed from the characteristics of indifference curves?

<p>They are downward sloping and convex to the origin. (D)</p> Signup and view all the answers

Which point represents an unattainable combination for the consumer based on the budget constraint?

<p>Point b (A)</p> Signup and view all the answers

What do the points c, d, and e have in common?

<p>They are all on the budget line. (B)</p> Signup and view all the answers

Why would a rational consumer not choose point a?

<p>It is below the budget line. (A)</p> Signup and view all the answers

Which statement correctly describes the Marginal Rate of Substitution (MRS)?

<p>It varies based on individual consumer preferences. (B)</p> Signup and view all the answers

If points c, d, and e yield the same utility, how does a consumer determine their preferred point?

<p>By selecting the point on a higher indifference curve. (B)</p> Signup and view all the answers

Which aspect differentiates the slope of the indifference curve from the slope of the budget line?

<p>The slope of the indifference curve reflects individual consumer preference, while the budget line reflects market prices. (D)</p> Signup and view all the answers

What is indicated when a consumer is at equilibrium?

<p>The MRS equals the price ratio. (A)</p> Signup and view all the answers

Which point among c, d, and e would typically be chosen to maximize consumer satisfaction?

<p>Point e, as it lies on a higher indifference curve. (A)</p> Signup and view all the answers

Flashcards

Utility

The satisfaction obtained from consuming a commodity; the want-satisfying power of a commodity.

Cardinal Utility

A utility theory where satisfaction from goods/services is measurable using numerical values (utils).

Ordinal Utility

A utility theory where satisfaction is ranked (e.g., first, second), not measured numerically.

Total Utility (TU)

The total satisfaction from consuming goods and services.

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Average Utility (AU)

Average satisfaction per unit consumed (TU / number of units).

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Marginal Utility (MU)

The extra satisfaction from consuming one more unit.

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Law of Diminishing Marginal Utility (LDMU)

As consumption increases, the extra satisfaction from each additional unit decreases (other things being equal).

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Indifference Curve (IC)

A curve showing combinations of two goods that give the same level of satisfaction to a consumer.

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Indifference Map

A set of indifference curves, each representing a different level of satisfaction.

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Marginal Rate of Substitution (MRS)

The rate at which a consumer is willing to trade one good for another while maintaining the same level of satisfaction.

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Budget Line

A line showing all possible combinations of two goods that a consumer can afford given their income and prices.

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Consumer Equilibrium

The point where a consumer maximizes their satisfaction given their budget constraint.

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utils

The unit of measurement for utility or satisfaction.

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Perfect substitutes

Two goods that a consumer views as the same, and can be substituted for each other.

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Perfect complements

Two goods that a consumer wants to consume together in fixed proportions.

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Rational Consumer

A consumer who makes decisions that increase their satisfaction or utility.

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Continuous Consumption

Consumption of a good without breaks, crucial for LDMU.

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Total Utility

The total satisfaction you get from consuming a certain amount of a good or service.

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Average Utility

The average satisfaction you get per unit of a good or service consumed.

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Indifference Curve Analysis

A tool used to show how a consumer chooses between two goods, based on their preferences and the idea of Ordinal Utility.

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What is the difference between Total Utility and Marginal Utility?

Total Utility measures the overall satisfaction from consuming a good, while Marginal Utility measures the additional satisfaction from consuming one more unit.

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Why is the Law of Diminishing Marginal Utility important?

It helps explain why we typically consume a variety of goods and services, rather than just one good, to maximize our overall satisfaction.

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What is the 'cardinal utility' assumption?

The assumption that you can assign a numerical value to your satisfaction level from consuming goods.

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What does the 'rational consumer' assumption mean?

Consumers are rational and make decisions that maximize their satisfaction or utility.

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The 'continuous consumption' assumption

The assumption that a consumer consumes units of a good without any breaks. It ensures that the marginal utility of each unit can be compared directly.

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Why are 'standard units' important?

Units of the good being consumed must be consistent to ensure a fair comparison of marginal utility.

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What does it mean for 'MU of money to remain constant'?

The consumer's money income stays the same during the analysis, preventing changes in buying power from influencing their consumption decisions.

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What is the 'no change in price' assumption?

The price of the good is constant, allowing the focus to be solely on the relationship between consumption and satisfaction.

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Why is the 'constant quality' assumption crucial?

The quality of the good must remain the same to avoid affecting your decision to consume more or less.

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Which assumptions are the most important?

The most fundamental assumptions are continuous consumption and standard units. They ensure that the law of diminishing marginal utility can be applied correctly and that consumption decisions are based solely on the satisfaction derived from the good itself.

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What happens to Total Utility (TU) when Marginal Utility (MU) is positive?

Total Utility (TU) increases as long as Marginal Utility (MU) is positive. This means consuming an additional unit brings satisfaction, albeit diminishing.

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What happens to TU when MU is zero?

Total Utility (TU) reaches its maximum when Marginal Utility (MU) becomes zero. At this point, consuming an additional unit provides no additional satisfaction.

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What happens to TU when MU is negative?

Total Utility (TU) starts decreasing when Marginal Utility (MU) becomes negative. This indicates that consuming an additional unit actually makes you worse off.

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What is the rational consumption point?

A rational consumer stops consuming a good when Marginal Utility (MU) becomes zero. This is because they've maximized their total satisfaction and consuming more doesn't improve it.

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Why is money an exception to the Law of Diminishing Marginal Utility?

Money doesn't follow the same pattern as most goods. No matter how much money we have, we tend to want more. It's hard to reach the point of feeling satiated by money.

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What does the Law of Diminishing Marginal Utility show?

This law shows that even though people have unlimited wants, they can satisfy individual desires to a point. The more you consume, the less satisfaction you get from each additional unit.

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What does the relationship between TU and MU illustrate?

The relationship between total utility and marginal utility shows how satisfaction changes with consumption. When TU is increasing, MU is positive. When TU is at its peak, MU is zero. When TU starts decreasing, MU becomes negative.

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How does the Law of Diminishing Marginal Utility help us understand consumer behavior?

This law explains why consumer preferences change with increasing consumption. It helps us understand why consumers choose not to buy unlimited quantities of any good, even if they like it.

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MRS

The rate at which a consumer is willing to trade one good for another while maintaining the same level of satisfaction.

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Diminishing MRS

As a consumer gets more of one good and less of another, they are willing to give up fewer units of the first good for one more unit of the second.

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Indifference Curve

A curve showing all combinations of two goods that provide the same level of satisfaction to a consumer.

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Why is an Indifference Curve Downward Sloping?

If a consumer gets more of good A, they need less of good B to maintain the same level of satisfaction. This leads to a downward slope, showing the trade-off.

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Why is an Indifference Curve Convex to the Origin?

The curve bends towards the origin because the MRS diminishes as the consumer has more of one good and less of the other.

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Higher Indifference Curve = Higher Utility

A higher indifference curve represents a higher level of satisfaction because it includes more of both goods, which a rational consumer prefers.

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Indifference Curves Never Intersect

Two indifference curves can never intersect because they represent different levels of satisfaction, and a consumer can't be equally satisfied at two different points simultaneously.

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MRS = Price Ratio

At consumer equilibrium, the Marginal Rate of Substitution (MRS) between two goods equals the ratio of their prices.

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Slope of Indifference Curve

Represents the Marginal Rate of Substitution (MRS): how much of one good a consumer is willing to give up to get one more unit of another good while maintaining the same level of satisfaction.

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Slope of Budget Line

Represents the price ratio of the two goods: the rate at which the market allows you to exchange one good for another.

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Point on a higher IC

A point on a higher indifference curve represents a higher level of satisfaction for the consumer.

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Point above the budget line

A point above the budget line is unattainable for the consumer because it's not affordable given their income and prices.

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Point below the budget line

A point below the budget line is attainable but not optimal for a rational consumer because they could get more satisfaction by spending more of their income.

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Why must an Indifference Curve slope downwards?

An indifference curve represents equal satisfaction. If it sloped upwards, consuming more of both goods would increase satisfaction, contradicting the definition. Same logic applies to horizontal and vertical slopes, where satisfaction would always increase.

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What happens if an Indifference Curve is concave to the origin?

A concave indifference curve implies increasing MRS (Marginal Rate of Substitution). This means the consumer is willing to give up more of one good for an additional unit of the other good.

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What does a straight-line, downward-sloping indifference curve represent?

A straight-line, downward-sloping indifference curve signifies a constant MRS. This indicates that the two goods are perfect substitutes, meaning the consumer values them equally.

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Why does a higher Indifference Curve represent higher satisfaction?

A higher indifference curve means the consumer can have more of one good, more of both goods, or the same amount of one and more of the other. This results in a higher level of satisfaction due to the assumption of non-satiety.

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What is the law of transitivity and how does it apply to Indifference Curves?

The law of transitivity states that if A is preferred to B, and B is preferred to C, then A is preferred to C. Applied to indifference curves, it means that no two curves can intersect because they represent different levels of satisfaction, creating a contradiction if they intersect.

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What is Diminishing MRS?

Diminishing MRS means that the rate at which a consumer is willing to trade one good for another decreases as they consume more of that good. This implies that the consumer values additional units of a good less than previous units.

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What is non-satiety?

Non-satiety is the assumption that consumers are never fully satisfied and always prefer more of a good to less. It forms the basis for the increasing satisfaction associated with higher indifference curves.

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Why does an Indifference Curve need to be convex?

A convex indifference curve reflects the assumption of diminishing MRS. It implies that as a consumer gets more of one good, they are willing to give up less of the other good to maintain the same level of satisfaction.

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Study Notes

What is Utility?

  • Utility is the satisfaction gained from consuming a commodity.
  • It can also be described as a commodity's "want-satisfying power."
  • Consumers experience delight and contentment when they consume desired goods. This is the feeling of utility.

Classification of Utility

  • Two main classifications: Cardinal Utility and Ordinal Utility
  • Cardinal Utility (developed by Alfred Marshall): Assumes utility is measurable, assigning numerical values to satisfaction levels.
  • Ordinal Utility (developed by Hicks & Allen): Assumes utility can only be compared, ranking preferences rather than assigning numerical values. This approach uses indifference curves.

Cardinal Utility Theory

  • Utility or satisfaction from goods/services is measurable.
  • Satisfaction levels can be numerically measured (utils).
  • Utility can be added when multiple goods are consumed. Example: Eating one chocolate (20 utils), a second chocolate (40 utils), and a pastry (80 utils), for a total increase in satisfaction.
  • Utilized 'utils' to measure satisfaction.
  • Law of Diminishing Marginal Utility (LDMU) is fundamental in Cardinal Utility approach.

Ordinal Utility Theory

  • Utility is not measurable, only comparable.
  • Ranking of alternatives (e.g., first choice, second choice) is the key.
  • Indifference curve analysis is based on ordinal utility theory.

Total Utility and Average Utility

  • Total Utility (TU): The total satisfaction a person receives from consuming goods and services (increases with additional consumption).
  • Average Utility (AU): The average satisfaction per unit of a good or service (AU = TU/number of units consumed).

Marginal Utility (MU)

  • Marginal Utility (MU): The change in total utility resulting from consuming one more unit of the same good or service.
    • MU = Change in Total Utility / Change in Quantity
    • MU=TUn-TUn-1

Law of Diminishing Marginal Utility (LDMU)

  • As consumption increases of a good, each additional unit provides less satisfaction than the previous one (marginal utility diminishes).
  • Key factors in LDMU include:
    • Continuous Consumption (consumption must be ongoing)
    • Standard units (the units of the commodity needs to be standard)
    • No change in price of the good
    • Quality of the good is constant
    • This law is relevant in microeconomics. However, there are exceptions; for example, addictive goods or rare items.

Indifference Curves

  • An indifference curve shows combinations of two goods providing the same satisfaction level to a consumer.
  • Higher curves represent higher levels of satisfaction.
  • Indifference curves never intersect.
  • Key concepts in indifference curves include:
  • Rationality: Consumers are rational and strive for maximum satisfaction.
  • Ordering Preferences: Consumers can rank goods.
  • Non-satiety: Consumers always desire more goods.
  • Consistency and Transitivity: Consumer choices are consistent and transitive.
  • Diminishing Marginal Rate of Substitution (MRS): As the quantity of one good increases, the amount of the other good a consumer is willing to give up for an additional unit of the first good decreases.

Budget Line

  • The budget line shows the maximum combinations of two goods a consumer can buy with a given income, given the price of each.
  • The budget line's slope depends on the relative prices of the goods.
  • Shifts in income or prices will shift the budget line.

Consumer Equilibrium

  • The point where the budget line is tangent to the highest possible indifference curve and is a point where the consumer is optimally allocating income to maximize their satisfaction given income and price constraints.
  • This point satisfies both conditions (ICs are downward sloping and tangent to the BL).

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Week 2: Utility PDF

Description

This quiz explores the concept of utility in economics, focusing on its definitions and classifications such as Cardinal and Ordinal Utility. Learn how consumer satisfaction is measured and the importance of these theories in understanding consumer preferences.

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