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Questions and Answers
What do consumers use to compare bundles of goods?
What do consumers use to compare bundles of goods?
Utility and usefulness are synonymous terms.
Utility and usefulness are synonymous terms.
False
What are the two approaches to measuring utility?
What are the two approaches to measuring utility?
Cardinal utility theory and ordinal utility theory
Consumers face _____ constraints, which limit the quantities of goods they can buy.
Consumers face _____ constraints, which limit the quantities of goods they can buy.
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Match the following terms with their meanings:
Match the following terms with their meanings:
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What is the focus of utility according to the content?
What is the focus of utility according to the content?
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Utility is the same for every individual regardless of their preferences.
Utility is the same for every individual regardless of their preferences.
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What are the two major approaches to measuring utility?
What are the two major approaches to measuring utility?
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According to cardinal utility theory, the satisfaction derived from consumption is measured in units called _____ .
According to cardinal utility theory, the satisfaction derived from consumption is measured in units called _____ .
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What does the cardinal approach assume about the rationality of consumers?
What does the cardinal approach assume about the rationality of consumers?
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Marginal utility of a commodity increases as more units are consumed.
Marginal utility of a commodity increases as more units are consumed.
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Name one assumption of cardinal utility theory related to money.
Name one assumption of cardinal utility theory related to money.
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Match the following terms with their definitions:
Match the following terms with their definitions:
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Which assumption of ordinal utility theory states that consumers maximize their satisfaction given their income and market prices?
Which assumption of ordinal utility theory states that consumers maximize their satisfaction given their income and market prices?
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The marginal rate of substitution represents the rate at which a consumer is willing to give up one commodity for another while remaining indifferent.
The marginal rate of substitution represents the rate at which a consumer is willing to give up one commodity for another while remaining indifferent.
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What is the property known as when a consumer prefers good X over good Y and good Y over good Z?
What is the property known as when a consumer prefers good X over good Y and good Y over good Z?
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Indifference curves are always _____ to the origin.
Indifference curves are always _____ to the origin.
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Match the properties of indifference curves with their descriptions:
Match the properties of indifference curves with their descriptions:
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What does a higher indifference curve indicate?
What does a higher indifference curve indicate?
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What does the total utility (TU) of a basket of goods depend on?
What does the total utility (TU) of a basket of goods depend on?
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Marginal utility (MU) increases as more units of a good are consumed.
Marginal utility (MU) increases as more units of a good are consumed.
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What is the formula for calculating marginal utility?
What is the formula for calculating marginal utility?
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The law of diminishing marginal utility states that as the quantity consumed of a commodity increases, the utility derived from each successive unit __________.
The law of diminishing marginal utility states that as the quantity consumed of a commodity increases, the utility derived from each successive unit __________.
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Match the following concepts with their definitions:
Match the following concepts with their definitions:
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Which of the following is NOT an assumption of the law of diminishing marginal utility?
Which of the following is NOT an assumption of the law of diminishing marginal utility?
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The cardinal utility approach assumes that utility can be measured objectively.
The cardinal utility approach assumes that utility can be measured objectively.
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What is one limitation of the cardinal approach to utility?
What is one limitation of the cardinal approach to utility?
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In the ordinal utility approach, consumers rank commodities in the order of their __________ preferences.
In the ordinal utility approach, consumers rank commodities in the order of their __________ preferences.
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Which statement accurately reflects a consequence of the law of diminishing marginal utility?
Which statement accurately reflects a consequence of the law of diminishing marginal utility?
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Study Notes
Chapter 3: Theory of Consumer Behaviour
- The chapter covers consumer behaviour in three steps: examining preferences, understanding budget constraints, and determining consumer choice.
- Consumer behaviour is best understood by examining consumer preferences, which describes how people prefer one good to another.
- Budget constraints impact consumer choices—limited incomes restrict the quantities of goods that can be purchased.
- Consumer preferences and budget constraints are combined to determine consumer choices.
3.1 Consumer Preferences
- Consumers make choices by comparing bundles of goods.
- If one bundle is strictly better than another, the consumer strictly prefers one to the other (symbolized as >).
- If consumers are indifferent between bundles, the symbol ~ is used (e.g., X ~ Y).
- If consumers weakly prefer one bundle to another, then X ≥ Y.
3.2 The Concept of Utility
- Economists use "utility" to describe satisfaction or pleasure derived from consuming goods or services.
- Utility represents the power of a product to satisfy human wants.
- Given two bundles (X and Y), if a consumer prefers X to Y, then the utility of X is considered better than the utility of Y.
3.3 Approaches of Measuring Utility
- There are two main approaches: cardinal and ordinal.
- The cardinal approach suggests utility can be measured objectively; using units like utils (e.g., orange = 10 utils, banana = 8 utils).
3.3.1 The Cardinal Utility Theory
- Utility is measurable by arbitrary units, like utils.
- This suggests that consumer satisfaction from goods can be quantified.
- Consumption of an orange gives more satisfaction than a banana, for example.
3.3.2 The Ordinal Utility Theory
- Utility isn't measured in numerical values; instead, goods and services are ranked from preferred to less preferred.
- Consumers rank goods in order of their standard preferences (e.g., 1st, 2nd, 3rd choices).
- Consumers' rational choices are based on their preferences, not on quantified utility.
Learning Outcomes
- After completing this chapter, students will be able to:
- Explain consumer preferences and utility
- Differentiate cardinal and ordinal utility approaches
- Define and discuss properties of indifference curves
- Derive and explain budget lines
- Describe consumer equilibrium conditions
Law of Diminishing Marginal Utility (LDMU)
- As consumption of a good increases, the utility derived from each additional unit decreases (all other things being equal).
- Consumers are rational.
- The goods consumed are homogenous (same quality, colour, etc.).
- No time gap is present in consumption
- Preferences remain unchanged
Consumer Equilibrium (One Commodity Case)
- Equilibrium occurs when the marginal utility of a good equals its market price (MUx = Px).
Consumer Equilibrium (Multiple Commodities)
- Equilibrium occurs when the marginal utility per unit of money spent is equal for all goods (e.g. MUx/Px = MUy/Py = ... = MUz/Pz).
- Consumer income will be spent completely.
Limitations of Cardinal Approach
- Utility is difficult to quantify objectively.
- The assumption of a constant marginal utility of money is unrealistic. As income increases, the marginal utility of money changes.
Assumptions of Ordinal Utility Theory
- Consumers are rational, maximizing utility given their income and prices.
- Utility is ordinal, not measurable in absolute numbers. Consumers rank preferences or order.
Diminishing Marginal Rate of Substitution (MRS)
- MRS is the rate at which a consumer is willing to substitute one good for another while staying on the same indifference curve.
- As a consumer consumes more of one good, they are willing to give up less of another to maintain the same level of satisfaction.
- Consumers' preferences for goods are consistent.
- Goods are interchangeable.
The Budget Line or the Price Line
- A budget line displays the combinations of goods that a consumer can afford, given prices and income.
- Changes in income or prices shift the budget line.
- An increase in income shifts the line outwards; increases in prices move it inwards.
Consumer Equilibrium under Indifference Curve Approach
- Equilibrium occurs where the indifference curve is tangent to the budget line, with the slopes being the same.
- Point 'E' represents where the consumer attains highest attainability of utility, consuming various combinations of goods 'X' and 'Y'.
Equilibrium of the Consumer
- Mathematically, consumer optimum(equilibrium) is attained at the point where the slope of the indifference curve equals the slope of the budget line.
- MUx/Px = MUy/Py = ... = MUz/Pz
Indifference Curve
- Shows various combinations of goods that provide equal levels of satisfaction for consumers.
- Downward sloping and convex to the origin.
- Higher indifference curves represent higher levels of satisfaction.
- Curves never cross.
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Description
Test your understanding of utility theory, including the cardinal and ordinal approaches to measuring consumer satisfaction. This quiz covers key concepts like marginal utility, constraints, and how consumers compare bundles of goods. Challenge yourself to match terms with their definitions and explore the focus of utility.
