Microeconomics: Consumer Choice Theory

Utility: The benefit consumers obtain from consuming a good or service.

In basic economic models, we assume that consumers are utility maximizing agents.

Utility maximization : consumers try to obtain the most satisfaction (or utility) as possible.

When a person consumes one extra unit of a good or service, they experience marginal utility. When the marginal utility is equal to zero, the utility from a particular good has been maximized.

The consumer increases their utility by increasing their consumption from Q1 to Q2. However, after Q2, if the consumer were to consume one more unit, they would experience negative marginal utility, decreasing their total amount of utility. Therefore, utility is maximized at Q2.

When a consumer pays for a good or service at the market clearing price, they will consume up until their marginal utility equals the price of their purchase.

Since there are multiple different goods and services in an economy, how does a consumer with a limited budget decide how much to consume from each good in order to maximize their utility? Economists use the utility maximizing rule in order to illustrated how consumers behave.

The utility maximizing rule: this rule states that a consumer's utility is maximized when the last dollar spent on each of the goods yields the same marginal utility. In other words:

$\textit{Utility is maximized when }\frac{MUx}{Px}=\frac{MUy}{Py}$

This formula is for two goods (x and y) only, but it can be extended.

Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 71-73.

Comments

Macroeconomics: real vs nominal gross domestic product

Nominal GDP: A nominal GDP measures the value of a nation's output produced in a year, given the prices charged for that year. However, if prices increase while the output level stays constant in a given year, the nominal GDP will drastically increase, even though the level of production is equal to that of the previous year. Estimating real GDP: To determine the actual change in output from one year to the next, we must adjust the nominal value of a country's output in a year based on changes in the average price level during that year. Inflation is when the price level increases, whereas deflation is when the price level is decreasing. To determine whether the nominal GDP overestimates or underestimates the output of a country, one must know whether the average price level has increased or decreased. In order to achieve this task can use a price index known as the GDP deflator. The GDP deflator: Real GDP is calculated by replacing the prices for that current year with tho...

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run. If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...

Macroeconomics: the money market and loanable funds market

The money market: The money market combines the supply of money and the demand for money for a country. The supply curve (Sm) is inelastic and is determined by the central bank. The demand curve (Dm) is the horizontal summation of the asset and transaction demand curves and is sloping downward. The intersection between the Sm and Dm is the equilibrium interest rate for a country. A change in the nominal interest rate implies that either or both curves (i.e Sm and Dm) have shifted to the right or left. An increase in nominal GDP (P*Y) will lead to an increase in the transaction demand for money which will shift the total demand (Dm) to the right. The nominal interest rate goes up. A decrease in the level of output (Y) will shift the Dm curve to the left. The Sm curve will shift whenever the central bank decides to change the money supply due to a monetary policy decision. The Fed expands the supply of excess reserves in commercial banks, by purchasing bonds from banks, Sm shi...

Economics and Statistics

Search This Blog