CONSUMER PREFERENCES & CHOICE

UTILITY ANALYSIS : Definition -Utility is the attribute of a commodity to satisfy a consumers want. Mathematically we can express utility as the function of the quantities of different commodities consumed. If an individual consumes quantity m1 of the commodity M, quantity n1 of N, then the utility function U of the consumer can be expressed as :
U=f(m1,n1)

UTILITY ANALYSIS
Utility analysis can be divided into cardinal utility analysis & ordinal utility analysis. The cardinal school believes that utility is quantifiable in units, whereas the ordinal school believe that utility cannot be measured, rather can be only shown as higher than or less than ranks.

CARDINAL UTILITY : According to earlier economists, utility is measurable like any other physical commodity and proposed utils as its unit. It is additive in nature. e.g.for a particular consumer a apple can have 2 utils, while a mango may have 3 utils. If a individual consumes a apple & a mango, then total utility is equal 2 + 3= 5 utils.

TOTAL AND MARGINAL UTILITY

Total utility(TU) refers to the sum total of utility levels out of each unit of commodity consumed within a given period of time.
Marginal utility(MU) is the change in total utility due to a unit change in the commodity consumed within a given period of time. MU = TUn - TUn-1

Marginal utility

# of slices of pizza total utility 0 0

marginal utility -

1
2 3 4 5 6

70
110 130 140 145 140

70
40 20 10 5 -5

Law of diminishing MU
law of diminishing marginal utility - marginal utility declines as more of a particular good is consumed in a given time period, ceteris paribus even though marginal utility declines, total utility still increases as long as marginal utility is positive. Total utility will decline only if marginal utility is negative

Consumer equilibrium
Consumers equilibrium is at the point where the budget line is tangent to the highest attainable indifference curve by the consumer, 1. subject to budget constraint.

Law of equimarginal utility

As per the law of equimarginal utility, a consumer will maximise utility when the marginal utility of the last unit of money spent on each commodity is equal to the marginal utility of the last rupee spent on any other commodity. If the utility from a commodity X, is more than that from another commodity Y , then the consumer would reduce consumption of Y and increase the consumption of X.The common marginal utility per rupee spent on all commodities is referred to as the marginal utility of income.The law of equimarginal utility can be expressed as:

Consumer surplus
Individuals buy an item only if they receive a net gain from the purchase (i.e., total benefit exceeds opportunity cost. This net gain is called consumer surplus.

Example
Suppose that an individual buys 10 units of a good when the price is $5

Benefits and cost of first unit

Benefit = blue + green rectangles (=$9) Cost = green rectangle (=$5) Consumer surplus = blue rectangle (=$4)

Total benefit to consumer

Total cost to consumer

Consumer surplus

Indifference curves
Indifference curve a graph of all of the combinations of goods that provide a given level of utility Any two points on an indifference curve provide the same level of utility

Points on and off an indifference curve

Alternative levels of utility

Budget constraint

Optimum consumption bundle