Lecture 3. Theory of consumer choice. Production and the marginal product. Fundamentals of Economic Theory Yevgeniy M. Orel, C.Sc.(Econ.), Docent, Faculty of Economic Science, NaUKMA

Thursday, July 23, Topic 3a Theory of consumer choice

Thursday, July 23, Outline of the presentation (Topic 3a) Total and marginal utilities (TU & MU) The law of diminishing marginal utility Determinants of consumer choice The rule of utility maximization Marginal utility and the demand curves down-sloping Budget restraint and the indifference curve Consumers point of equilibrium and the demand curve

Thursday, July 23, Total and marginal utilities [1] UTILITY (корисність) – The pleasure or satisfaction derived by an individual from being in a particular situation or from consuming goods or services.

Thursday, July 23, Can utility be measured? Cardinal (absolute) utility? Ordinal (relative) utility?

Thursday, July 23, Use versus utility Apples and oranges? Candies and ice-cream? Sad movies and soap operas? Cigarettes and narcotic drugs?

Thursday, July 23, Total and marginal utilities [2] TOTAL UTILITY (загальна корисність) – …total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service. (C.McConnell, S.Brue)

Thursday, July 23, Total and marginal utilities [3] MARGINAL UTILITY (гранична корисність) – …the extra satisfaction a consumer realizes from an additional unit of a product. (C.McConnell, S.Brue) MARGINAL UTILITY – …the change in total utility resulting from the consumption of one more unit of a product. (C.McConnell, S.Brue)

Thursday, July 23, Total and marginal utilities [4] MU n =TU n –TU n-1 n – number of consumed goods/services MU – marginal utility (гранична корисність) TU – total utility (загальна корисність)

Thursday, July 23, The law of diminishing marginal utility* Each extra unit of a commodity consumed lets consumer gain less satisfaction that the previous one. Every extra unit of a good or service consumed within a relatively short period of time brings less utility than the previous one: MU n < MU n-1 *Ukr: Закон спадної граничної корисності

Thursday, July 23, The law of diminishing marginal utility in action Chocolate bars consumed by a student during an break between classes Marginal utility (utils) Total utility (utils) 1 st bar 6 62 nd bar 3 93 rd bar th bar -2 8

Thursday, July 23, Determinants of consumer choice Rational behavior Tastes and preferences Budget constraints Prices

Thursday, July 23, The rule of utility maximization The total utility will be the greatest possible if each hryvnia spent on the last item of each good or service brings the consumer equal utilities: MU 1 /P 1 = MU 2 /P 2 = … = MU n /P n

Thursday, July 23, Marginal utility and the demand curves down-sloping The lower the price, the lower the utility that can offset the consumers expenditures, and thus the greater the quantity of goods he consumer will buy.

Thursday, July 23, Budget restraint and the indifference curve Budget restraint line is a straight line. Indifference curve is a curve because of the law of diminishing marginal utility.

Thursday, July 23, Consumers point of equilibrium and the demand curve Consumers equilibrium is reached in the point of tangency between the budget restraint line and an indifference curve.

Thursday, July 23, Topic 3b Production and the marginal product

Thursday, July 23, Outline of the presentation (Topic 3b) Production function Total, average and marginal products The law of diminishing marginal productivity Isoquants Leontieffs production function Neoclassical production function The marginal rate of substitution

Thursday, July 23, Production function Production function (виробнича функція) equation (a mathematical expression ) that reveals relationship between output and inputs needed to create that output.

Thursday, July 23, Total, average and marginal products Total product (загальний продукт) is the total output produced with a combination of certain quantities of inputs. Average product (середній продукт) is the total output divided by the quantity of the input. Marginal product (граничний продукт) is the output produced as a result of applying an incremental unit of input.

Thursday, July 23, The law of diminishing marginal productivity After some point, the more of a variable input is added to a certain fixed input, the lesser the additional output will be obtained.

Thursday, July 23, Isoquants Isoquant, isoquant curve, (ізокванта) is a curve representing different combinations of factors (inputs) resulting in the same amounts of output.

Thursday, July 23, Neoclassical production function

Thursday, July 23, Leontiefs production function

Thursday, July 23, Wassily Leontief,

Thursday, July 23, Marginal rate of substitution [1] Marginal rate of technological substitution (MRTS) (граничний коефіцієнт технологічного заміщення) is a ratio of a unit of one input (A) we add to the amount of another input (B) we give up for the sake of using the unit of the input A, the output remains the same.

Thursday, July 23, Marginal rate of substitution [2] Graphically, MRTS determines the slope of the isoquant. Replacing one input with another means movement from one point of the isoquant to another, provided the output remains the same. Changes in output result in shifting to another isoquant.

Thursday, July 23, Дякую за увагу! Thank you for attention!