Microeconomics: UTILITY

UTILTIY

A measure of the satisfaction or happiness a consumer derives from consuming a good or service. it is subjective and varies from person to person.

LAW OF DEMAND

is a fundamental economic principle that explains how consumers behave when price changes. As the price of a good or service increases, the quantity demanded decreases and vise versa.

CONSUMER BEHAVIOR

The study of how individuals make decisions about what to buy, use, and dispose of goods and services.

RATIONAL BEHAVIOR

The assumption that consumers make decisions in a way that maximizes their utility, given their contraints.

LAW OF DEMAND CONCEPTS: INCOME EFFECT

When a price of a good decreases consumers have more real income. This means they can buy more of that good or other goods.

Example: If bread becomes cheaper you might buy more bread or spend money on other items.

LAW OF DEMAND CONCEPTS: SUBSTITUTION EFFECT

When one good becomes relatively cheaper, consumers tend to substitute it for more expensive goods.

*consumers shift their purchasing towards goods that provide better value*

LAW OF DIMINISHING UTILITY.

As you consume more of a good the additional satisfaction (Marginal Utility) from each additional unit decreases.

This explains why the demand curve slopes downward*

As price increases the quantity demanded decreases and vise versa.

THEORY OF CONSUMER BEHAVIOR

The theory of consumer behavior uses utility analysis to explain how consumers make choices to maximize their satisfaction, given their preferences, income and the price of goods and services.

*RATIONAL BEHAVIOR

consumers aim to maximize their utility

PREFERENCES

Consumers have clear preferences for different goods and services

INCOME

consumers have a limited budget or income

PRICES

Goods and services have prices that consumers must pay

MARGINAL UTILTIY

is the additional satisfaction gained from consuming one more unit of a good or service. The relationship between marginal utility and price helps explain the shape of the demand curve.

MU

The change in total utility resulting from consuming one additional unit of a good or service.

DEMAND CURVE

A graphical representation of the relationship between the price of a good or the service and the quantity demanded.

DIMINISHING MARGINAL UTILITY

The principle that as consumption of a good increases, the marginal utility derived from each additional unit decreases

CONSUMER EQUILIBRIUM

The point at which a consumer allocates their income to maximize their total utility, given the prices of goods and services. This occurs when the ratio of MU is equal for all goods

TIME CONSTRAINTS

Consumers face time constraints in addition to budget constraints.

RISK AVERSION

Consumers generally prefer less risk to more risk, given the same expected utility.

BEHAVIORAL ECONOMICS

A field that combines insights from psychology and economics to better understand consumer behavior. Often challenging the assumptions of traditional utility analysis.

OPPORTUNITY COST OF TIME

The value of the next best alternative use of one’s time.

TIME ALLOCATION

The process of deciding how to spend one’s time on different activities

UTILITY MAXIMIZATION

Consumers allocate their time to activities that provide the greatest utility, considering the opportunity cost of time.

KARL MENGER (1871)

One of the pioneers of the Austrian school of economics, which emphasized subjective value and marginal analysis.

WILLIAM STANLEY JEVONS (1871)

A british economist who independently developed similar ideas about marginal utility

LEON WALRAS (1874)

A french economist who contributed to the development of general equilibrium theory, which incorporates marginal utility.

HERMANN HEINRICH GOSSEN (1854)

A german economist who formulated Gossen’s laws, which anticipate the concept of diminishing marginal utility.

CONSUMER SURPLUS PRINCIPLE

measures the additional value a consumer gains from a purchase. It represents the difference between the maximum price a consumer is willing to pay for a good or service and the actual price they end up paying.

DEMAND CURVE (CONSUMER SURPLUS)

SHOWS HOW MUCH CONSUMERS ARE WILLING TO PAY FOR EACH UNIT OF PRODUCT.

MARKET PRICE

The actual price at which a good or service is sold in the market place.

CONSUMER SURPLUS

THE ECONOMIC BENEFIT CALCULATED AS THE ARE UNDER THE DEMAND CURVE AND ABOVE THE MARKET PLACE.

TOTAL UTILTIY

the overall satisfaction derived from consuming a good

SCARCITY

The limited availability of a good relative to the demand for it.

PARADOX OF VALUE

refers to the observation that essential goods like water, often have low prices, while non-essential goods like diamonds, often have high prices. The paradox is resolved by considering marginal utility rather than total utility.

MARGINAL UTILITY PRINCIPLE

PRICE IS DETERMINED BY THE LAST UNIT CONSUMED. INCREMENTAL VALUE MATTERS MORE THAN TOTAL VALUE.