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Module 4.1 Consumption Theory

The document discusses key concepts in consumer theory, including: 1) Ordinal and cardinal utility, which rank preferences but only cardinal measures magnitude of differences; 2) The law of diminishing marginal utility, where extra satisfaction from consuming more decreases; 3) Consumer equilibrium, where utility is maximized given income and prices; 4) Budget lines which represent affordable combinations of goods given prices and income; 5) Indifference curves which represent equal levels of satisfaction from different combinations; and 6) Marginal rates of substitution which measure how much a consumer is willing to give up of one good for another.

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Charice Anne Villamarin
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158 views12 pages

Module 4.1 Consumption Theory

The document discusses key concepts in consumer theory, including: 1) Ordinal and cardinal utility, which rank preferences but only cardinal measures magnitude of differences; 2) The law of diminishing marginal utility, where extra satisfaction from consuming more decreases; 3) Consumer equilibrium, where utility is maximized given income and prices; 4) Budget lines which represent affordable combinations of goods given prices and income; 5) Indifference curves which represent equal levels of satisfaction from different combinations; and 6) Marginal rates of substitution which measure how much a consumer is willing to give up of one good for another.

Uploaded by

Charice Anne Villamarin
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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The

Consumption
Theory-
continuation
Utility can be measured in one of two ways:
• Ordinal utility ranks a series of options in order of preference. This ranking does not
show how much more valuable one option is than another, only that one option is
preferable over another. An example of a statement reflecting ordinal utility is that “I
would rather read than watch television.” Generally, ordinal utility is the preferred
method for gauging utility.

• Cardinal utility also ranks a series of options in order of preference, but it also
measures the magnitude of the utility differences. An example of a statement
reflecting cardinal utility is “I would enjoy reading three times more than watching
television.” Given how difficult it is to precisely measure preference, cardinal utility is
rarely used.

https://courses.lumenlearning.com/boundless-economics/chapter/the-demand-curve-and-utility/ 2
The Law of Diminishing Marginal Utility
This theory states that as an individual consumes
more units of commodity per unit of time, his total
utility increase reaches its maximum and starts to
decrease. It means that as more goods are
consumed, the extra satisfaction or marginal utility
received decreases.
Consumers’ Equilibrium
When a consumers’ utility is maximized with regard
to his income, it means that he is in equilibrium.
Mathematically, this can be expressed as :
MUx = MUy
Px Py

Such that, PxQx+PyQy+… = M(Income)


Optimal Choice of Goods for Consumer- a consumer is in equilibrium

5
Budget line is a graphical representation of
all possible combinations of two goods which
can be purchased with given income and
prices, such that the cost of each of these
combinations is equal to the money income
of the consumer.
Budget Line

https://www.economicshelp.org/blog/glossary/indifference-curves/

7
Shift in Budget Line

Due to change in income Due to change in the price of Good X

8
Marginal Rate of Substitution
the maximum amount of a good that a
consumer is willing to give up in order to
obtain one additional unit of another good.

MRS measures the value that the individual


places on 1 extra unit of a good in terms of
another.
toppr.com/guides/business-economics-cs/theory-of-consumer-behavior/marginal-rate-of-substitution/
10
Types of Marginal Rate of Substitution
Diminishing
The marginal rate of substitution is diminishing. One can obtain it if the consumer is willing to
give up less and less unit of good Y for every additional unit of good X.
Constant
The marginal rate of substitution is constant also. One can obtain this if, for one more unit of Y,
only one unit of X is given up. It is constant for perfect substitution.
Increasing
Suppose a consumer substitutes a commodity X for the other commodity Y at an increasing rate
to maintain the same level of satisfaction. In this case, one can obtain an increasing marginal
rate of substitution.

toppr.com/guides/business-economics-cs/theory-of-consumer-behavior/marginal-rate-of-substitution/
toppr.com/guides/business-economics-cs/theory-of-consumer-behavior/marginal-
rate-of-substitution/

https://courses.lumenlearning.com/boundless-economics/chapter/the-demand- R eferences
curve-and-utility/

https://www.economicshelp.org/blog/glossary/indifference-curves/

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