Utility, Indifference Curve & Budget Line

Vocabulary flashcards covering key concepts from the notes about TU, MU, IC, BL, and related concepts.

Total Utility (TU)

The overall satisfaction from consuming a good or service in a given period; TU increases with quantity but at a diminishing rate.

Marginal Utility (MU)

The extra satisfaction gained from consuming one more unit of a good; MU = ΔTU/ΔQ.

Utils

Units used to measure utility or satisfaction.

Law of Diminishing Marginal Utility

As consumption increases, MU from each additional unit falls, so TU grows at a diminishing rate.

Equi-Marginal Principle

To maximize total utility with a fixed budget, allocate spending so the last dollar on each good yields the same MU per unit of price (MU/P is equal across goods).

Indifference Curve (IC)

A curve showing all combinations of two goods that give the same level of satisfaction.

Indifference Map

A set of indifference curves representing different levels of satisfaction.

Budget Line (BL)

The line that shows all affordable bundles given income and prices; slope is -P1/P2 (the budget constraint).

Normal Good

A good for which demand rises as income rises.

Inferior Good

A good for which demand falls as income rises.

Giffen Good

A rare inferior good where higher price leads to higher quantity demanded because the income effect dominates the substitution effect.

Substitution Effect

When price changes, consumers substitute toward relatively cheaper goods; movement along the same indifference curve.

Income Effect

The change in consumption resulting from the price change's impact on real purchasing power; can shift to a different indifference curve.

Rational Behavior

The idea that consumers aim to maximize satisfaction given constraints.

Preferences

Consumers' clear ranking of goods/services available in the market.

Budget Constraint

The fixed limit on consumption choices due to income and prices.

Price

The monetary value of a good or service; used to allocate spending and influence MU.

Utility Maximizing Rule

A rational consumer maximizes total utility by equalizing the last dollar marginal utility across goods (MU1/P1 = MU2/P2 = …).

Assumptions of the Utility Maximizing Rule

Rational behavior, fixed income, given prices for all goods, and unchanged tastes/preferences.

MU per price Equality (MUA/PA = MUB/PB)

The condition used to allocate spending so that each dollar spent yields the same marginal utility across goods.

MU Curve and Demand Curve

In this framework, the marginal utility curve is closely related to the individual’s demand curve; MU generally declines as quantity rises, implying downward-sloping demand.

Diminishing MU and TU relationship

When MU is positive, TU increases; MU = 0 means TU is at a maximum; MU negative means TU declines.

Conditions for Purchasing

A rational consumer will not buy a unit if the marginal utility from it is less than its price.

Optimal Bundle (IC ∩ BL)

The point where an indifference curve is tangent to the budget line represents the best affordable combination.

Normal vs Inferior vs Giffen in price movement

Normal: income rises accompany higher demand; Inferior: demand falls with income rise; Giffen: higher price may raise quantity demanded due to strong income effect.

Equi-Marginal Principle - Example idea

We decide allocations so MU/Price are equal, e.g., MUA/PA = MUB/PB.

Indifference Curve Properties

Downward slope, convex shape, higher curves imply higher satisfaction, curves never intersect, and never touch axes.

Substitution vs Income Effects on ICs

Substitution effect: movement along same IC due to relative price change; Income effect: shift to a different IC due to change in purchasing power.

Budget Line shifts with income

An increase in income shifts BL outward (parallel), a decrease shifts it inward.

Limitations of MU Theory

MU approach assumes precise measurement of utility, perfect rationality, stable tastes, and ignores complex multi-good decisions.