1. CONSUMER CHOICE
The Theory of Demand

2. Two major approaches to utility
KARDINAL
direct measuribility of utility
Tools used:
- Total utility curve
- Marginal utility curve
ORDINAL
immeasurability of utility
Tools used:
Indifference analysis
Basic assumption: consumer can rank market baskets (the most desired basket is ranked first)

3. CARDINAL APPROACH TO UTILITY
Utility = satisfaction consumers receive from items they require, activities they engage in, or services they use
Total utility = total satisfaction enjoyed from consuming any given quantity čit´s a subjective concept
Marginal utility = the extra satisfaction a person receives over a given period by consuming one extra unit of a good

4. Relationship of Total and Marginal Utility
Quantity of good consumed
Total utility
Marginal utility 1 4 2 7 3 9 10 5
The relationship between total and marginal utility can be expressed also graphically. The figure of total utility shows how the total utility depends on the amount of consumed good èthe ratio represents than the slope of total utility curve.

5. Relationship TU and MU graphically

6. 1. Gossen´s law
The law of diminishing marginal utility – the amount of extra or marginal utility declines as a person consumes more and more of a good
čUtility tends to increase as you consume more of a good, however, according to the law of diminishing marginal utility, your total utility will grow at a slower and slower rate

7. Consumer Equilibrium
As a rational consumer, you presumably seek to obtain the greatest possible utility from your limited monthly income.
On condition we don´t have to pay anything for a good, the equlibrium level of consumption of that good would be the amount that brings us the highest total utility.
Equilibrium amount of a good will be bought than, as long as the marginal utility equals the price of that product:
MU = P

8. 2. Gossen´s law
The law of equal marginal utilities per dollar/euro.. = equimarginal principle
to maximize utility, consumer must equalize the marginal utility per euro spent on each good
(MU of income)

9. Deriving of demand curve
The demand curve represents a relationship between the marginal utility of a good and the quantity consumed, other things beings equal
A higher price for a good reduces the consumer´s optimal consumption of that commodity, therefore for each price exists the quantity demanded corresponding the consumer optimum è downward-sloping demand curve!

10. ORDINAL APPROACH TO UTILITY
INDIFFERENCE CURVES
A graph of various market baskets that provide a consumer with equal utility
Different individual will naturally rank market baskets differently
Main characteristics:
·  convex to origin – represents the „law of substitution“
·  downward-sloping
· there is always an infinite number of curves
·  they never intersects mutually
THE BUDGET CONSTRAINT
Budget line = represents all alternative combinations of two goods that consumer can afford considering his fixed income (assuming fixed prices).
The equation of budget line is:
The slope:

11. Consumer equilibrium
Represents that combination of goods purchases that maximizes utility subject to the budget constraint
Geometrically, the equilibrium can be described as that combination of goods corresponding to the point at which the budget line is just tangent to the highest attainable indifference curve in the consumer´s indifference map

12. Indifference analysis

13. DERIVING THE DEMAND CURVE
Kept other things constant, when the price of X has increased, it will mean that the less of that product you can afford with your income
č graphically it means the change of the budget line slope – it becomes steeper and therefore will touch different indifference curve (representing lower level of utility) è each price corresponds other optimal point and therefore different quantity of good demanded, in that way we can construct the demand curve (individual)

14. CONSUMER SURPLUS
= the gap between the total utility of a good and its total market value
The surplus arises because we „receive more than we pay for“, it is rooted in the law of diminishing marginal utility
we pay for each unit what the last unit is worth – but by the law of diminishing marginal utility the earlier units are worth more to us than the last èthus, we enjoy a surplus of utility on each of these earlier units

15. Consumer surplus

16. Tasks:
1. Can be TU positive and MU negative at the same time? Draw graphs and explain.
2. Knowing following dates:
a) Draw the graphs of TU and MU curves.
b) Calculate, how high consumer surplus you´ll get, when the market price of good is 8 Eur and decide, how many units you will consume.
3. Px = 120 Eur and Py = 80 Eur. Graphically show, what will happen when Px has increased by 18 Eur and at the same time Py by 12 Eur. Use the tools of indifference analysis.
4. Your function of TU is: TU = 10X – X2 . (where X is quantity of good consumed per week).
a) Write the equation of MU and decide, at what level of consumption start TU decrease?
b) Derive and draw TU and MU curves.
c) Assume Px = 6 Eur. By what level of consumption of good X will household maximize its utility, knowing, that the ratio MU/P for all other goods = 1)? Q 1 2 3 4 5 6 7 TU 20 36 48 56 60 58