Consumer Behaviour and Utility Theory

Vocabulary practice flashcards covering consumer behaviour, cardinal utility, ordinal indifference curve analysis, and demand theory.

Cardinal Approach

An approach to consumer theory based on the assumption that utility can be given a direct, numerical measurement.

Ordinal Approach

An approach to consumer theory based on ranking and comparisons of preferences using indifference curves and budget lines rather than absolute numerical measurement.

Utils

An imaginary unit assumed in cardinal utility analysis to measure levels of satisfaction or utility.

Total Utility ($TU$)

The overall satisfaction received by a consumer from consuming all units of a good within a given time period, ceteris paribus.

Marginal Utility ($MU$)

The additional satisfaction gained from consuming one more or the last additional unit of a good.

Law of Diminishing Marginal Utility (DMU)

The economic principle stating that as consumption of a good increases over a given time period, the satisfaction derived from each additional unit declines ($Q \uparrow \rightarrow MU \downarrow$).

Disutility

Dissatisfaction or negative marginal utility ($MU < 0$) that occurs when additional consumption causes total utility to fall ($TU \downarrow$).

Willingness to Pay ($WTP$)

The monetary measurement of marginal utility ($MU$), representing the economic value assigned by a consumer to an additional unit of a good.

Consumer Equilibrium (Single Good)

The point where total utility is maximized for a single good by consuming up to the quantity where price equals marginal utility ($P = MU$).

Equimarginal Utility Principle

The rule for multiple goods analysis stating that a consumer maximizes total utility when the marginal utility per dollar spent is equal across all goods in the bundle ($\frac{MU_X}{P_X} = \frac{MU_Y}{P_Y}$).

Diamond-Water Paradox

The paradox of value where water is essential for survival but has low market value due to low marginal utility from abundant supply, whereas diamonds have high market value because high scarcity yields high marginal utility ($MU_{\text{diamond}} > MU_{\text{water}}$).

Substitution Effect

The change in consumption resulting from a relative price change, where a consumer substitutes away from a good that offers lower utility per dollar toward relatively cheaper alternatives to maintain total utility.

Income Effect

The change in the combination of goods consumed resulting from a change in real income or purchasing power caused by a price change.

Price Effect

The net impact of a price change on quantity demanded, formed by the combination of the substitution effect and the income effect ($\text{Substitution Effect} + \text{Income Effect} = \text{Price Effect}$).

Normal Good

A good whose consumption increases as consumer income rises ($\text{YED} > 0$), and where the substitution and income effects operate in the same direction following a price increase.

Inferior Good

A lower-quality good whose consumption decreases as consumer income increases ($\text{YED} < 0$), where the income effect works in the opposite direction of the substitution effect.

Giffen Good

A low-quality necessity with no affordable alternatives where a price rise leads to an increase in quantity demanded ($P \uparrow \rightarrow Q_d \uparrow$) because the negative purchasing power / positive income effect outweighs the substitution effect.

Veblen Good

A high-value luxury good for which quantity demanded rises when its price rises due to its status or prestige appeal.

Indifference Curve ($IC$)

A downward-sloping curve showing all combinations of two goods that provide the consumer with an identical level of total utility.

Marginal Rate of Substitution ($MRS$)

The gradient of an indifference curve, representing the rate at which a consumer is willing to trade one good for another while maintaining the same total utility ($MRS = \frac{MU_X}{MU_Y}$).

Budget Line

A line showing all possible combinations of two goods that a consumer can purchase by fully exhausting a given money income at constant prices ($P_X \cdot X + P_Y \cdot Y = \text{Income}$).

Income Consumption Curve (ICC)

A curve showing how the equilibrium consumption bundle of two goods shifts as consumer income changes, holding relative prices constant.

Engel Curve

A curve derived from the income consumption curve showing the relationship between consumer income and the quantity demanded of a particular good.