Theory of Choice and Utility

• In session 2, the objective is to develop a theory of choice to understand how people make decisions.
• Preferences regarding goods and constraints, like income and prices, affect people choices.
• The assumption of Ceteris Paribus is important.

Utility

• Utility defines pleasure or satisfaction from economic activity
• Utility depends on the amounts of different things, and other outside factors.
• Utility = U(X, Y; other things)
• Other factors outside of X and Y are to kept constant.
• Measuring utility presents the problem of ceteris paribus and also measurement units
• Cardinal utility is not the same as ordinal utility.

Three Assumptions About Preferences

• Preferences are assumed to be complete, meaning that given two options, a person can state which option they prefer or whether they find both options equally attractive.
• The assumption of transitivity means preference is internally consistent, If A to B is preferred and B to C is preferred then A to C is preferred.
• More is better, for economic "goods" and "bads".

More is Better w/ Combinations

• Combinations of goods (X and Y) in the green area of a graph are preferred to (X*, Y*).
• Combinations of goods (X and Y) in the red area are less preferred to (X*, Y*).

Indifference Curves

• An Indifference curve determines to compare points, and plot different regions of a graph.
• Two goods used in indifference curves are soft drinks and hamburgers.
• Indifference is a curve that shows combinations that give same utility level.
• Indifference means utility remains the same.

Indifference Curves and Negative Slope

• Indifference curves have a negative slope
• The trade off between two goods, more soft drinks are needed if hamburgers are given up to achieve the same utility
• As you move along the curve, preferences change to reflect the trade off.

Marginal Rate of Substitution (MRS)

• The marginal rate of substitution is the rate at which someone reduces one good for one more unit of another.
• The absolute value of the slope of the indifference curve determines MRS

Diminishing Marginal Rate of Substitution

• The number of burgers someone is willing to give up for soda gets smaller as soda increases.
• Known as diminishing marginal rate of substitution
• People prefer balanced consumption to extreme

Indifference Curve Map

• Utility a person gets from combinations of two goods is shown
• Utility increases as you move northwest
• U3 > U₂ > U₁

Particular Preferences

• A useless good is where more of it neither helps nor hurts utility.
• An economic bad is where more of it decreases utility.

Perfect substitutes and Complements

• Perfect substitutes have a constant MRS.
• Perfect complements are consumed together in fixed proportions.

Utility Maximization

• Choice from goods gives highest utility.
• Decision constrained by income and prices.
• Ex: A consumer with $100 a week to spend on burgers and soda must allocate the budget to maximize utility.
• Two conditions to maximize utility: spend all income and ensure that MRS is equal to price ratio.
• With MRS = 1, consumers give up a burger to get 1 soda.
• If soda is $1 and a burger is $2, MRS would be 1 > PS/PB = 1/2.
• With one less burger, additional soda is obtained while keeping consumers indifferent.

Utility Maximization Graphically

• The opportunity can be limited by Budget constrain and be represented this way:Total amount spent on X and Y = Total income

Budget Constraints

• Budget constraints algebra includes I for dollars of income, X and Y for goods, and Px and Py for prices
• An equation can rewrite as Y = (I/Py) - (Px /Py)X
• I/Py describes buying Y units and I/Px buying X units.
• The slope shows the opportunity cost of X in terms of foregone Y

Maximizing Utility

• It takes constraints and adding indifference curves
• Point A is affordable but does not spend all the income.
• By point B, MRS (the slope of the indifference curve) > price ratio (the slope of the budget constraint)
• Less burgers and more soda lead to a higher curve at C
• C is where maximum utility is achieved

Types of Models & Goods

• Differences between person’s preferences over goods
• Persons with stronger preference are at a steeper curve
• Person only buys food if the useless good offers no utility.
• Person will avoids goods that are economic bad
• The person buys shoes only in pairs.

Numerical Examples in Models

• When identical, only the lowest price gas is bought.
• Extra utility from more expensive good leads a consumer to buy.
• Each good is to be used together (i.e. left and right shoes)

Generalizations and Maximizations

• People make choices, while maximizing or aiming to increase there overall utility and happiness.
• Indifference shows combination a person views as equality as attractive
• MRS measures how much a person wants to switch good for another
• A person will maximize utility through spending and choosing the mix of goods for which the MRS = price ratio.

Demand Sessions

• Previously, you learned about how to maximize utility.
• The current objective is to use the model of utility maximization, to how to get and make demand curves.

Individual Demand Functions

• A demand function shows how quantities demanded depend on prices, income, and preferences.
• Can be shown equation-wise as the quantity of X demanded = dx(Px, Pү, I; preferences)
• The demand for goods related for specific things are the price of soda, price of related good, income, other general perferences
• The consumer preferences are assumed to not change

Individual Demand Functions; Homogeneous

• A double goods and incomes doesn't affect behavior as long as the relative price are kept consistent
• In short, demand functions are homogeneous

Changes in Income

• As income rises quantity does as well, if the income is normal / high
• Quantity purchased is decreased in inferior / lower income goods

Inferior vs Normal Goods

• Suppose before your income increases from 11 to 13
• As your income increases, you buy more Y but buy less Z, therefore Y and Z is normal and inferior

Change in a Good's Price

• The quantity of purchased good goes based on its own price increasing or decreasing
• Income/Substitution are affected
• Substitution holds the effect on consumption due to change
• Income has the effect of consuming due to change

Substitution Effects on Goods

• The consumer maximizes utility
• As price goes down on X, the amount of utility rises
• To change to a different effect

What The Price Change Shows

• The change in economy and money
• Consumers now buy a lot more due to economic change

Numerical Example (Burgers)

• Utility is affected by the number of burgers one obtain, as well as its price of the sort
• By getting $30, PBurger is $3 and Psoda is $1.50 , 5 buggers and 10 sodas maximize its way to make utility
• Psoda is 1.50, which affects the outcome as a result

What Inferior Goods Do

• The effects is how if people have the ability or choice to have a better outcome in mind
• For example
  • The income effect leads to less X.
  • Since overall the consumption of X increases when the price of X falls and the substitution effect > income

Effects When Income Changes

• The change in how much one can actually afford
• Depends on new price on how much each are bought
• Example includes whether or not a drink is an inferior amount of quantity

More About Increase

• So to see the subsitution effect, new budger has to shift around
• The Income effect will show the change
• There are steps to figure such out in a graph

The Lump Sum Priniciple

• The taxes have the smallest value on most consumers
• This works by comparing all income taxes
• There are many subsitutions
• And Income affects these taxes

What The Graph Show

• Government increase to make more revenue
• Income affects
• High costs

Graphs of Demand Curve

• Individual demand is one where all relevant context are constant (taste and income)
• Shown diagram use to find the individual

Demand Curve (3/4)

• As the price changes
• More people are to buying

Shifts On Curve

• The shape is depend upon Income and Subsition affectiveness
• Many may have few of subsitution
• Such as effects for Breakfast

Demand

• The result of this will change
• There was a constant rate
• Example if a good become useless
• This shifts for people the price changes to goods

Shifts In graph

• There can be Increases, but this affect what we know as a set of shifts graph

Comment On Terminology

• Do not confuse words
• Demand and quanties are 2 seperet things
• Change is done, demand isn't because change affects all factors though

Defining Model

• The Demand and Value is very import
• Consuming and buying all affect these

Consumer

• We focus on one on each, it can lead to valueing

Cost of a curve

• Is what the other person wants to pay
• As they purchase t-shirts it shows their surplus
• To get the maximum value

Price and Maximization

• The price the person receives affects total worth
• We get to find the total utility to these values

Graph

• Utility is set to get all items
• Such like Shirts

What Results

• To compensate if mainted equal we maximize equal
• Equal on both end

Curves of What is Market

• Curves is the increase or fall
• People decide to buy
• In income and other cases affect all demand

Example To see

• To be the only set of people
• There are charts that measure who and what

Another Good Example of Demand

A change

What is Important to Model

• Measure to help is way to do things
• In a variety of ways

More Terms

• We see that are several important terms to know here

Unit Curve

• Important term
• Spend is same at the same
• Equation is used for a important purpose

Terms We can use

• They are not important to show
• Important info

Production

• We turn over to firms to change the three questions asked
• There happens to number put uses
• Some more stuff

Functions

• Input is output
• Functions relate to one another and output
• Basic to know

Average Product (workers)

• Product are divide by worker
• Show effective those product works
• Practility can important

More Info

• Important combination of how

Technical

• How to keep same and all numbers to get same level

Marginal

• The slope falls as they

Tech

• And so forth all that

Example

• If any

Sum

• And stuff

The End

• Important things