5. Consumer’s behavior: the ordinal utility theory

Cardinal utility theory(marginal utility theory)	Ordinal util. theory
1)Measures utility 2) util – unit of utility	3) Tries to avoid measurement 4) Only ranks and order of preferences.

1. 

Assumptions (preferences are):

Complete – consumer can make a choice and decide what he wants.

Reflexive – any bundle of goods are as good as itself.

Transitive – consumer is consistent in his preferences, there is no contradictions in his behavior.

Ex.: If X>Y and Y >Z  consumer prefers X

Well behaved preferences:

Monotonic – assumes that there is a free disposal of goods and refers only to good, not to bads(MU<0).

!!! The more you consume the better, NO point of satiation(насыщение)

Convex(curve with no flat parts) – if we take

three extreme points and take weighted average

it will be better than extremes.

Move along the IC to the → => MRS↓ => each additional unit of X becomes less valuable in terms of good Y(diminishing MU law), that is why the curve is convex.

Indifference curve(ic) and its properties.

IC – a set of points that characterizes all the combinations of two goods which yield the same TU.

General form of the well-behaved IC – points on the curve correspond to the different bundles of goods, but they give the same TU. A consumer is indifferent between these bundles of goods.

MRS – marginal rate of substitution – shows how many units of good Y a consumer is willing to give up in order to get one more unit of good X.

An individ. consumer has an infinite numb. of IC and the curves characterize a preference map(PM) of the consumer.

Each consumer has his unique PM, and each IC corresponds to certain level of utility and TU↑ in the north-east direction.

IC of the same PM don’t cross, as each curve shows a certain level of TU. If they cross => the point of intersection has the same util. for both curves, and it contradicts the definition.

Indifference curve, its shape and mrs

1. Good X and Y are perfect substitutes. (EX: black and blue pens) => MRS = --1

2. Perfect complements. (EX: left and right shoe)

3. Good & bed products. ( Y↑ => X↑ in order to compensate the negative effect). MRS = positive.

4. Neutral & good products. MRS=infinity.

1) 2)

5) Integer case. (EX: auto, fridge etc).

6) Point of Satiation(насыщение). A -- the best combination.

1. G o

!!! If we consume too much of one good, or of both goods, they become bads.

!!! Consumer eats only X or Y.

!!!Consumer combines X and Y.

Utility function and consumer’s optimal choice(COC).

COC – a cons. wants to max. his TU, but he is restricted by his income and market prices, so his optimal choice must be according to them.

!!! point B – an optimal choice – tangent point of budget constraint(BC) and the highest possible IC.

!!! All the curves to the right of the BC are not affordable.

	If Py < Px => cons. will buy Y => optimal point is on the y-axis and vice versa… If Py = Px => there can be any number between two extremes.