S&N, Ch. 5, App.

5
Mw, pp. 137-142

THEORY OF THE
CONSUMER
Utility
Diminishing marginal utility
 Marginal utility – Ex.

Quantity Total utility Marginal utility

0
consumed 0
U MU
Q 4
1 4
3
2 7
2
3 9
1
4 10
0
5 10
Equimarginal principle

MU1 = MU2 = MU3 = …

P1 P2 P3
Equimarginal Principle

 Good A has a smaller marginal utility

per $ than good B,
 Buying $1 less of A and $1 more of B
will increase the total utility.
Why demand curves slope
down
Consumer Surplus

 Consider the following demand

schedule
 Price Quantity
 4 1
 3 2
 2 3
 1 4
 Suppose the equilibrium price is $2
Consumer surplus

 Three people will buy the product at

$2
 According to the demand schedule,
 one person was willing to pay $4 (i.e.
their value or utility for this product
was $4)
 another person was willing to pay $3
(utility = $3)
 the third was only willing to pay $2
 The first two buyers get more utility
than they pay for, the last gets
Consumer Surplus
Consumer Surplus
Price

A
Consumer

Surplus

PE P E
B C 
Producer
D Surplus 

Quanti
ty
Producer Surplus
Choosing between
combinations
 A consumer has a choice of two
products, food at $1 a unit and
clothes at $2 a unit.
 She has a fixed budget of $50
 How many units of food and how
many units of clothes will she buy?
 If she spends all of her budget on f
units of food and c units of clothes,
her budget constraint is f + 2c = 50
Indifference curves

 Certain combinations of food and

clothes will provide the same utility,
e.g.
 20 units of food and 15 units of
clothes,
 21 units of food and 14 units of clothes
 The consumer is indifferent to
choosing between combinations
with the same utility
 A line of equal utility is an
indifference curve
 Indifference curves

is indifferent. That is, at each point on the curve, the consu

Indifference curves

50 I123
, , are indifference
curves with different
utilities
Fo
od
(u
ni A Increasing
ts utility
)
I3
Budget constraint line
I
I 2
1
25 Clothes
(units)
Choosing between
combinations
 The optimal combination of goods is
the point at which the budget
constraint line is tangential to (just
touches) an indifference curve –
Point A
 This gives the maximum utility for the
available budget
Next week

 Theory of the firm

 S&N, Ch. 6, 7, Appendix 7
 Mw, pp. 143-158, Ch 13