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ECO200Y1a - Consumer Theory.doc Utility Theory O NE G OOD U TILITYT HEORY Cardinal measure of utility precise, accurate, numerical measurement. Assume one good X: Total UtilitTU X . TU X( ) Marginal Utility =X( ) X . Diminishing marginal utility Can get too much of a good thing.. Example: Deriving Demand MU drives D diminishing marginal utility leads to a P negatively sloped D. Constant marginal utility of money constant value everywhere. 4 D1 2 Q 4 5 6 MU 10 8 6 4 2 MU Q 4 5 6 C ONSUMER SURPLUS The difference of the value of the commodity and how much the consumer spend on it. Consumer surplus comes about because every unit is the same price, but consumers value each unit differently. Example 1 Given p= 12 2q , atp =2, CS = 5 122 =)5 . 2 Note the $5 difference is due to the extra area from the triangles. TWO G OOD UTILITY FUNCTION TU X,Y = TU X +TU Y( ) X and Y are not related goods. MU X MU Y Equilibrium: = P X PY Page 1 of 21 www.notesolution.com ECO200Y1a - Consumer Theory.doc MU X MU Y MU MU X MU Y Y Y PX PY PX MU XP X PY xxxx B xxxx xxxx xxxx xxxxA xxxx X Y X Y PX MU X MU Y = . PX PY If P , then Q . X X D Q Indifference Theory INDIFFERENCE C URVES Definition All points with the same level of satisfaction. Assumptions Consumers are able to rank given A and B, they are able to pick the preferred one. Transitivityrationalconsistent if A > B > C, then A > C. More is preferred to lesMU > 0 . Derivation C B is preferred to A (more of both goods) and A is preferred to C (more of both goods), so B and C are C not on IC IC negatively sloped. C F B <0 C F . F Typically non-linear: A C IC TU due t + TU due to = 0 TU TU C + F =0 F C F . MU C + MU F =0 C = MU F F MU C Page 2 of 21 www.notesolution.com