## Unit 4 Study Guide: The Consumer

#### 4a: Identify and describe the basic tenets of consumer theory through two alternate approaches: the utility analysis and the indifference analysis.

• Define utility analysis and marginal utility.
• How do consumers choose between two goods?
• Define the utility maximization rule using marginal utility per dollar.
• What does the law of diminishing marginal utility indicate?

Utility and Marginal Utility

The theory of consumer choice relies on the concept of utility, which is another word for consumer satisfaction or happiness. As individuals seek to maximize their utility, specific behaviors often guide their choices. Concepts to help analyze choices are marginal utility and marginal utility per dollar.

Things are not always what they seem or what we expect. Review Sheena Iyengar's discussion about making choices in her Ted Talk, The Art of Choosing.

Review consumer theory and consumer equilibrium in the following resources.

• Define the indifference curve and describe how they measure utility.
• Define a budget line and describe how it limits consumer choices.
• How do you determine optimal consumer choice for an individual, when you put the indifference map and the budget line together?

Indifference Curves and Budget Lines

The concepts of consumer preference and utility help us understand how individuals compare goods and services. For example, individuals have to consider their budget limitations and how much money they have available to spend to make an optimal choice. We put consumer preferences and budget on the same graph to analyze consumer choice.

• Define and describe how you represent the income effect and substitution effect graphically.

During your review, pay particular attention to income and substitution effects that arise from changes in a consumer's income, and the price of one or both of the goods.

Review consumer choice and optimization, subject to a budget constraint, in the following resources.

#### 4b: Correlate the derivation of the theory of demand to the theory of consumer behavior.

• How does a price increase affect the quantity a consumer can afford to buy?
• How should we reflect a change in price in the indifference curve, budget line framework, and the choice an informed consumer will make regarding the optimal quantities of the goods?

The indifference curve and budget constraint provide the foundation for the demand curve, which represents the negative relationship between price and quantity demanded (i.e. as price increases, quantity demanded decreases). Consider how we can use the consumer optimization framework to derive this relationship.

You can translate and represent these changes on an individual's demand curve.

Review how to construct a demand curve in the following resources.

#### Unit 4 Vocabulary

• Budget constraint line
• Consumer equilibrium
• Demand curve
• Diminishing marginal utility
• Income effect
• Indifference curves
• Indifference map
• Law of diminishing marginal utility
• Marginal utility
• Marginal utility per dollar
• Substitution effect
• Total utility
• Utility analysis
• Utility maximization rule