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Consumer Theory

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A Normed Topic in Economic Analysis 

Consumer Theory

This topic introduces students to the basic principles of consumer theory in microeconomics. Students are introduced to a number of key concepts that are essential for the economic analysis of public policy including: the behaviour of demand curves, consumer surplus, budget constraints, important assumptions about consumer preferences and utility maximization.

Topic Learning Outcome: Appropriately utilize and interpret results of applying consumer theory to the analysis of public policy and management problems.

Core Concepts associated with this TopicAssumption of Convex Preferences; Assumption of Monotonic Preferences; Assumption of Transitive Preferences; Budget Constraint; Budget Set;  Consumer Optimization Principle; Consumer's Surplus; Demand Curve; Indifference CurveMarginal Rate of Substitution; Marginal Utility; Optimal Choice; Optimization Principle; Reservation PriceTechnical Rate of Substitution; Utility. 

Recommended reading

University of Toronto: PPG-1002
Varian, Hal R., and Jack Repcheck. Intermediate microeconomics: a modern approach. Vol. 6. New York, NY: WW Norton & Company, 2010. (Chapter 3 (Pp. 34-56))

Carleton Unversity: PADM-5111
Frank, Robert, Ian Parker, and Igela Alger. Microeconomics and Behaviour, 5th Canadian Edition. New York: McGraw-Hill, 2013 (Chapter 5)

Harvard Kennedy School: API-101
Pindyck, Robert S. and Daniel L. Rubinfeld. Microeconomics, 8th Edition. Prentice-Hall, 2012 (
Chapter 3 and 4)

NYU Wagner: GP-1018
Mankiw, N. Gregory. Principles of Microeconomics, 6th edition. Mason: South-Western College Publishers, 2011. (Chapter 21) 

Johnson-Shoyama: JS-805
Krugman, Paul, Robin Wells, and Anthony Myatt. Microeconomics: 1st Canadian Edition. London: Worth Publishers, 2006. (Chapter 10)

Ford School of Public Policy: Public Policy 555 
Pindyck, Robert S., and D. Rubinfeld. Microeconomics, 7th edition. Upper Saddle River: Patience-Hall, 2007 (Chapter 3)

George Washington: PPPA-6003
Mankiw, N. Gregory. Principles of Microeconomics, 6th edition. Mason: South-Western College Publishers, 2011. (Chapter 5)

American: PAUD-630
Krugman, Paul and R. Wells, Microeconomics, 3rd edition. London: Worth Publishers, 2012. (Chapter 4, 7, and 8)

UCLA: PLC-201
Goolsbee, Austan, Steven Levitt, and Chad Syverson. Microeconomics. New York:  Worth Publishers, 2013 (Chapter 4)

Rutgers- Economics in Public Policy
Pindyck, Robert S., and D. Rubinfeld. Microeconomics, 7th edition.  Upper Saddle River: Patience-Hall, 2007 (Chapter 3 and 4.1)

Possible Assessment Questions:

  1. Provide a one or two sentence definition of the following terms: Assumption of Convex Preferences; Assumption of Monotonic Preferences; Assumption of Transitive Preferences; Budget Constraint; Budget Set;  Consumer Optimization Principle; Consumer's Surplus; Demand Curve; Indifference Curve; Marginal Rate of Substitution; Marginal Utility; Optimal Choice; Optimization Principle; Reservation Price; Technical Rate of Substitution; Utility.
  2. In each of the following examples, a consumer purchases just two goods: x and y. Based on the information in each of the following parts, sketch a plausible set of indifference curves (that is, draw at least two curves on a set of labeled axes, and indicate the direction of higher utility). Also, write down a utility function u(x, y) consistent with your graph. Note that although all these preferences should be assumed to be complete and transitive (as required for utility representation), not all will be monotone.
    a) Jessica enjoys bagels x and coffee y, and consuming more of one makes consuming the other more enjoyable.
    b) Plamen loves mocha swirl ice cream x, but he hates mushrooms y.
    c) Jennifer likes Cheerios x, and neither likes nor dislikes Frosted Flakes y.
    d) Edward always buys three white tank tops x for every pair of jeans y.
    e) Nancy likes both peanut butter x and jelly y, and always gets the same additional satisfaction from an ounce of peanut butter as she does from two ounces of jelly.
    [Note: This problem and the next are from MIT's Open Courseware at http://ocw.mit.edu/courses/economics/14-01sc-principles-of-microeconomics-fall-2011/unit-2-consumer-theory/problem-set-2/MIT14_01SCF11_assn02.pdf, accessed 5 February 2015.] 
  3. A consumer’s preferences are representable by the following utility function: u(x, y)= x(raised to the 1/2 power) + y.
    a) Obtain the MRS of the consumer at an arbitrary point (¯x, y¯), where ¯x> 0 and ¯y> 0.
    b) Suppose the price of the second good (y) is 1, and the price of the first good (x) is denoted by p> 0. If the consumer’s income is m> 0, obtain the optimal consumption bundle of the consumer (in terms of m and p). [Caution: make sure you cover cases in which m is relatively low, as well as cases in which m is relatively high.]

Page created by: Joshua Tan and Ian Clark, 5 February 2015.

 

 

 

 

 

 Useful Resources on the Portal Related to this Topic

  Microeconomics Links and Resources

 Concepts used in this topic

  Consumer Optimization Principle
  Consumer's Surplus
  Demand Curve
  Indifference Curve
  Budget Constraint
  Budget Set
  Utility
  Assumption of Convex Preferences
  Assumption of Monotonic Preferences
  Assumption of Transitive Preferences

 Reference collections relevant to this topic

  Consumer Theory

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School of Public Policy and Governance