Lecture on Utility & Budget

Israt Hossain, Lecturer

BA, DIU

Consumption preference and possibilities.

Consumption preference and possibilities
• A buyer’s choice of goods and services- consumption choices—are
influenced by
Consumption Possibilities.
Consumption Preferences.

• Consumption possibilities are all the things that one can afford to buy.

• Consumer Preferences—a description of one’s likes and dislikes.

Consumption Possibilities
• Consumption possibilities are limited by income and prices.

• We describe this limit with a budget line.

• So, A budget line is the boundary between those combinations of

goods and services that a household can afford to buy and those that
it cannot afford.

• The budget equation starts with the fact that, Expenditure = Income.
Consumption Possibilities
• For example, if Lisa buys only two goods: Soda and Movies, her expenditure
=(Price of soda * Quantity of soda) + (Price of movie * Quantity of movies).

 PsQs + PmQm = Y

QS + Pm /PS * Qm= Y/ Ps ; Pm/Ps = Relative Price of movie

Qs=Y/Ps- Pm/Ps* Qm

Relative price of Soda= 1/ (Pm/Ps)=Ps/Pm

 Price change
Effect on
Budget Line
• The lower the price of the good
measured on the x-axis, other things
remaining the same, the flatter is the
budget line.
• Budget line rotate inward or outward
based on how product’s price changes.
• From which side budget line will rotate,
is dependent on which product’s price
changes.
Income Change
Effect On
Budget line
• A change in money income changes real
income but does not change the relative
price.
• The budget line shifts, but its slope does
not change.
• A decrease in money income decreases
real income and shifts the budget line
leftward.
Consumption Preferences
• Consumer’s preference is the description of one’s likes and dislikes.

• A popularly used way to describe consumer preference is Utility.

• Utility is defined as the benefit or satisfaction that a person gets from

the consumption of goods and services.

• We distinguish two utility concepts: ■ Total utility ■ Marginal utility.

 Total Utility : The total benefit that a person
gets from the consumption of all the
different goods and services is called total
Total utility.
Marginal utility is the change in total utility
Utility & that results from a one-unit increase in the
Marginal quantity of a good consumed.

Utility Total utility depends on the level of

consumption—more consumption generally
gives more total utility.
Total Utility &
Marginal Utility
• Total utility depends on the level of
consumption—more consumption
generally gives more total utility.

• The tendency for marginal utility to

decrease as the consumption of a good
increases is so general and universal that
we give it the status of a principle—
the principle of diminishing marginal utility.
Total Utility & Marginal Utility
• All the things that people enjoy and want more of have a positive
marginal utility.

• Some objects and activities can generate negative marginal utility—

and lower total utility. e.g: hard labor and polluted air.

• We can get the marginal utility curve from the slope of the total utility
curve.
• Change of Total utility/ change of total quantity = Marginal Utility
 Indifference Curve
• People can sort all the possible combinations of goods into three groups:
preferred, not preferred, and indifferent by a preference map.

• An indifference curve is a line that shows combinations of goods among

which a consumer is indifferent.

• An individual prefers all the combinations of goods and services above

the indifference curve.

• She prefers any combination on the indifference curve to any

combination below the indifference curve.
Indifference Curve
Marginal Rate Of Substitution
• The marginal rate of substitution (MRS) is the rate at which a person
will give up good y to get an additional unit of good x, while remaining
indifferent (remaining on the same indifference curve).

• If the indifference curve is steep, the MRS is high, that is, the person is
willing to give up large quantity of y to get an extra unit of good x.

• If the indifference curve is flat, the MRS is low, that is, the person is
willing to give up small quantity of y to get an extra unit of good x.
 Marginal Rate
of Substitution
• A diminishing marginal rate of
substitution is a general tendency
for a person to be willing to give up
less of good y to get one more unit
of good x, while at the same time
remaining indifferent as the quantity
of x increases.

• The shape of a person’s indifference

curves incorporates the principle of
the diminishing marginal rate of
substitution because the curves are
bowed toward the origin.
Best Affordable
Choice
• On the Budget Line.

• On the Highest Attainable

Indifference Curve.

• Marginal Rate of Substitution

Equals Relative Price.

• In the example, willingness to

pay for a movie equals her
opportunity cost of a movie.