Consumer behavior: the cardinal utility theory.
Utility is satisfaction from consumption. Util – unit of utility.
MU= additional satisfaction gained from consuming one extra unit of a good within a given time period.
TU= satisfaction consumer gets from consuming all units of good consumed within given time period.
Cardinal (marginal) utility theory: it is possible to measure utility. Significance is paid to magniture. Used in marketing and trade.
Law of diminishing marginal utility: in a given time period you can consume (n) units of good. Each next unit is giving you less utility → MU is diminishing.
M
arginal
utility shows the slope of a total utility curve. MU=TU’
Budget constraint shows all combinations of two goods that a household could buy if it spent all income.
TU maximization takes place if MU = 0 (no budget restrictions; price = 0) and if MU = P (market good; not free)
Marginal rate of substitution shows how many units of good Y a consumer is willing to sacrifice in order to get one more unit of good X. MRS=MUx/MUy; in equilibrium MRS=Px/Py
Consumer behaviour: the ordinal utility theory.
O
rdinal
theory of utility attaches the significance to the orders or ranks of
utilities (Slutsky, Pareto, Hicks). The main instrument is
indifference curve:
set of points that shows all possible combinations of two goods that
yield same TU. The slope of indifference curve is MRS=MUx/MUy=Px/Py.
Other shapes of indifference curve are:
Income and substitution effects of a price change: Slutski and Hicks approaches.
Income effect: price grows, real income (not nominal, but what we can afford) falls, we are worse of and demand less goods.
The substitution effect: price of good x grows, other prices are constant, so all other goods are now relatively cheaper; and a consumer always tries to buy cheaper goods → consumer buys less of good x and more of others.
Hicks: Real income is constant if TU is constant.
Slutski: Income is constant if purchasing power is constant.
For normal goods both effects are negative. For inferior goods the substitution effect is negative, but the income effect is positive. Giffen goods (“very-very inferior”): positive income effect is larger than the negative substitution effect.
Production function and scale effects.
Production function shows relationship between inputs and outputs. It describes the boundary of production set and measures maximum possible output that you can get from a given amount of input.
Isoquant curve = set of points showing all possible combinations of K and L that give same level of output. Slope: MRTS=MPL/MPK=PL/PK
Isocost curve = combinations of K and L that cost the same
-If inputs increase slower than output, there is a positive scale effect, or economies of scale, or growing returns to scale.
-If inputs increase faster than output, there is a negative scale effect, or diseconomies of scale, or decreasing returns to scale.
-If inputs and output grow at the same rate, there is a neutral scale effect, or constant returns to scale.