Two Key Ideas in the Model of Consumer Choice (see also Suggestions for Completing Problem Set 2)

Idea #1: Deciding Expenditures on Each Good

• Have limited income, goods A, B, C, etc., sell at prices per unit of PA, PB, PC, etc.

• Is utility associated with each unit consumed of each good

• Term marginal utility denotes utility of last or next unit consumed of a good

• For example, MUA = Utility from last (or next) unit consumed of good A

• If consumer determines expenditures on each good to maximize utility, then:

MUA/PA = MUB/PB

--Utility per last dollar spent on each good must be equal

• If condition not satisfied then consumer could increase utility via alternative expenditure

• Increase expenditure on good with higher MU/P, lower expenditure on other

• Problem 1 on Problem Set 2 on cheeseburgers and beer illustrates: MUB = MUC and PB > PC, so MUB/PB < MUC/PC and should ­ C, ¯ B

• Condition can be used to identify optimum

• Allocation of time (analogous to income) to maximize total/average test score (analogous to utility) on Problem 2 on Problem Set 2 concerning test scores on economics, math, and statistics

• Manipulating condition: MUA/MUB = PA/PB

• Prices must reflect relative marginal utilities of each good

• Problem 6 on Problem Set 2 on martinis and beers, MUM > MUB

• Applies only to marginal unit, so can’t tell anything about total/average utilities from all units consumed of each good—applies to Problem 4 on Problem Set 2 and Problem 2 on Mixed Bag I

Idea #2: Relative Consumer Well Being at Two Times with Same Preferences

• Sometimes able to determine relative location of budget lines at two times

• If one inside other, then can order well being—Problem 3 on Problem Set 2, part of Problem 4 on Mixed Bag I

• If budget lines cross, if can locate consumption bundle in one period inside other period’s budget line then can determine relative well being—Problem 5 on Problem Set 2, Problems 3, 4, and 5 on Mixed Bag I