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READING & VIDEO OUTLINE

Intermediate Microeconomics – Dr. Sauer

Chapter 3: Consumer Preferences and the Concept of Utility 3.1 Representations of Preferences A market basket or bundle is a

Consider a basket that contains two goods: food and clothing. Reference Figure 3.1 to complete the following: Basket G contains _____ units of clothing and _____ units of food. Basket B contains _____ units of clothing and _____ units of food. Basket J contains _____ units of clothing and _____ units of food. Consumer preferences are indications of

Assumptions about consumer preferences 1. Preferences are ________________________. - this means - notation for “A is preferred to B” ________________ - notation for “A and B are equally preferred” _____________ 2. Preferences are _________________________. - this means 3. ________________ is better. Ordinal and Cardinal Ranking Ordinal ranking refers to

Cardinal ranking refers to

3.2 Utility Functions A utility function is

Preferences with a single good: the concept of Marginal Utility [screencast] Watch the video for this section and fill in the notes here. Suppose Sarah purchases only one good, hamburgers. h denotes the number she purchases each week. Her utility function is given as U(h) =

**Let’s graph her Total Utility function.
**

U(h)

0

1

2

3

4

5

6

h

Sarah’s preferences are ____________________________: - each value of h yields a value of U(h), so baskets can be ______________________ Sarah’s preferences are ____________________________:

Sarah’s preferences satisfy ___________________________ . - more h yields a higher value for U(h).

__________________________ Marginal Utility is defined as

Formula:

Graphically speaking:

Watch the video for this section and fill in the notes here. [screencast] Finding marginal utility from total utility Recall that marginal utility is the slope of total utility. The expression for slope can be found by taking the first derivative. If utility is derived from one good, x, then the expression for marginal utility is found as follows:

Example:

U(h) =

MU(1) =

MU(h)

MU(2) =

MU(3) =

MU(4) =

MU(5) =

0 1 2 3 4 5 6 h

___________________________________________ When drawing Total Utility and Marginal Utility curve, keep the following in mind: 1.

2.

3.

The principle of diminishing marginal utility states that

Is more always better?

Preferences with Multiple Goods: Marginal Utility, Indifference Curves, and the Marginal Rate of Substitution Review Figure 3.4.

In the case of multiple goods, the marginal utility of any one good is:

For U(x,y)

the MUx measures: the MUy measures:

Work through the LBD exercise 3.1 here: The utility function is U =

[screencast]

Show that this consumer believes more is better for each good. More is better:

Show that U is increasing in x and y. - show that U has a ___________________ slope - show that MUx and MUy are __________________

Show that the marginal utility of x is diminishing. Show that the marginal utility of y is diminishing.

__________________________________________________________________ Work through the LBD exercise 3.2 here: [screencast]

Does this consumer believe more is better? Is utility increasing in both H and R? 1. look at U 2. look for positive MU

Is there diminishing marginal utility for H? Is there diminishing marginal utility for R?

________________________________________________ Indifference Curves An indifference curve is

4 properties of Indifference curves: 1. When the consumer likes both goods, indifference curves have a _____________ slope.

2. Indifference curves cannot ________________.

3. Every basket lies on ______________________________ indifference curve.

4. Indifference curves are not _________________.

The Marginal Rate of Substitution

[screencast]

The Marginal Rate of Substitution is the rate at which a consumer is willing to __________________ to get an ________________________________ while holding utility ____________.

The MRSx,y is the ______________________________________ of the indifference curve. Derive: Suppose a consumer changes their consumption of x by Δx and changes their consumption of y by Δy. The change in utility (ΔU) can be expressed as follows: ΔU = MUx (Δx) + MUy (Δy)

Since we are on a given indifference curve, the change in utility is zero. ΔU = 0

__________________________________ Diminishing Marginal Rate of Substitution

Work through the LBD exercise 3.3 here:

[screencast]

1. If both marginal utilities are positive, then the indifference curve has a negative slope.

2. Do the indifference curves cross either axis?

3. Is MRSx,y diminishing?

Work through the LBD exercise 3.4 here:

[screencast]

1. If both marginal utilities are positive, then the indifference curve has a negative slope.

2. Do the indifference curves cross either axis?

3. Is MRSx,y diminishing?

3.3 Special Preferences Perfect Substitutes Perfect substitutes (in consumption) are The general utility function that describes these preferences is:

Example: Suppose a consumer is always willing to substitute 2 pancakes for 1 waffle. The utility function that would express this preference is given by:

The marginal utility of pancakes is: The marginal utility of waffles is: If pancakes is the x-variable and waffles is the y-variable, then the MRSp,w is: The slope of the indifference curve is: Illustrate on a graph.

Perfect Complements Perfect complements (in consumption) are The general utility function that describes these preferences is: Illustrate on a graph.

Cobb-Douglas Utility Functions A Cobb-Douglas utility function takes the form:

Three desirable properties of the Cobb-Douglas functional form: 1. 2. 3.

Quasilinear Utility Functions A quasilinear utility function is The general equation is: Illustrate on a graph.

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