Preference, Utility and Budget Line

Flashcards on Consumer Preference and Utility based on lecture notes.

Utility

The want satisfying power of a commodity.

Utility

Anticipated satisfaction by the consumer.

Satisfaction

Actual satisfaction derived by the consumer.

Cardinal Utility: Marginal Utility Analysis

Theory propounded by Marshall that explains how a consumer spends his income on different goods and services to attain maximum satisfaction.

Ordinal Utility: Indifference Curve Analysis

Theory propounded by Hicks and Allen that explains how a consumer spends his income on different goods and services to attain maximum satisfaction.

Total Utility

The sum of utility derived from different units of a commodity consumed by a consumer.

Marginal Utility

The addition made to total utility by the consumption of an additional unit of a commodity.

Rationality

A consumer is rational and attempts to attain maximum satisfaction from his limited money income.

Cardinal Measurability of Utility

Utility is a measurable and quantifiable entity that can be measured in cardinal numbers.

Constancy of the Marginal Utility of Money

The marginal utility of money remains constant throughout when the individual is spending money on a good.

The Hypothesis of Independent Utility

The total utility which a person gets from the whole collection of goods purchased by him is simply the sum total of the separate individual utilities of the goods.

Law of Diminishing Marginal Utility

As a consumer consumes more and more units of a good, the intensity of his want for the good goes on decreasing.

Saturation point

When marginal utility is zero, total utility is maximum.

Homogenous units

The different units consumed should be identical in all respects.

Continuous Consumption

There should be no time gap or interval between the consumption of one unit and another unit i.e. there should be continuous consumption.

Equilibrium

A state of rest or a position of no change, which under a situation provides the maximum gain.

Consumer’s Equilibrium

A situation in which a consumer has maximum satisfaction with limited income and does not tend to change his existing way of expenditure.

Law of Equi-Marginal Utility

The consumer will be at equilibrium when the MU of commodities x and y will be equal to their respective prices.

Complete Preferences

An agent has complete preferences if she can compare any two objects.

Transitive preferences

An agent has transitive preferences if her preferences are internally consistent.

Indifference relation

If the agent weakly prefers x to y (i.e. x ≤ y) and weakly prefers y to x (i.e. y ≤ x) then she is indifferent between x and y.

Monotonicity

A consumer always prefers more to less i.e. More is better

Indifference Curve

Any curve or a graphical representation of the combination of different goods providing the same satisfaction level to the consumer

Indifference Map

Representation of consumer preferences by a number of indifference curves.

Indifference Schedule

A table or a schedule that shows different combinations of two goods giving the same level of satisfaction to the consumer

Utility is ordinal

The utility gained from the consumption of a good cannot be measured in cardinal numbers like 1, 2, 3, etc.

Marginal Rate of Substitution

The amount of Good Y sacrificed to obtain an additional unit of Good X without affecting the total satisfaction level.

Axiom 4

Preferences have Monotonicity i.e. Non Satiation.

Axiom 5

Preferences have Convexity of ICs.

Budget Line

The set of bundles that cost exactly m.

Slope of the Budget Line

The rate at which the market is willing to “substitute” good X for good Y.

Quantity tax

Consumer has to pay certain amount to the government for each unit of good purchased.

Value Tax

The tax that is imposed on the value or the price of the good.

Lump-sum Tax

A fixed amount of tax that government collects irrespective of the quantity or the value of the good.

Quantity Subsidy

The government gives an amount to the consumer that depends on the amount of good purchased.

Value Subsidy

The subsidy is based on the price of the good that is being subsidized.

Lump-sum Subsidy

It directly adds to the money income and The amount given to the consumer is fixed irrespective of the quantity or the value of the good.

Rationing

The level of consumption of some good is fixed to be no larger than some amount.

Well-behaved Preferences

Downward sloping, smooth, convex to the origin indifference curves/maps.

Cobb-Douglas utility function

Given by u(x1, x2) = x1 αx2 β , α amd β > 0.

Perfect Substitutes

When goods can be perfectly used in place of one another

Perfect Complements

Represents preferences where the 2 goods must be consumed together in a fixed proportion

Economics Bads

Goods which the consumer does not want but ends up consuming.

Neutral Good

A good is said to be neutral if the consumer doesn’t care about consuming it or not.

Satiation

There is some overall best bundle for the consumer, and the “closer” he is to that best bundle, the better off he is.

Quasi-linear Preference

An agent has quasi-linear preferences if they can be represented by a utility function of the form u(x1; x2) = v(x1) + x2

Concave preferences

A two-good consumer likes to have more of both the goods, i.e., both the goods are MIBs to him, but he does not like to have both the goods at the same time.

Lexicographic Preferences

Lexicographic preferences describe comparative preferences where an economic agent prefers any amount of one good (X) to any amount of Good (Y)