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Tutorial 1

Olga Petranevskaya
[email protected]
Attendance is compulsory (yes, even online,
even exactly at the time of classes)
Participation in discussion and answering
questions will give you points, don’t be shy, btw
preparations to classes will help you with this
No additional, extra or whatever individual tasks
will be given, even don’t try to ask
Passing of this subject is a cumulative result of
entire semester
There will be zero exam (mainly based on
semester results), exam and retake. There wont
be ANY additional terms. If you miss any of them,
you should take part in the next one.
Everything will be discussed during classes or in
channels in chats. There is no need to re-ask
individually in the private chat on Teams
On order to be able to take part in the exam
you should be present and participate in the
class. Max 2 absence allowed
 Grading scale:
95-100 = 6
90-93 = 5
80-89 = 4,5
70-79 = 4
60-69 = 3,5
50-59 = 3
0-49 = F (Fail)
Final Exam – 50
Attendance and class participation – 30
Assignments, case study, homework, tests - 20
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The theory of consumer choice focuses on how consumers
with limited resources choose goods and services

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Businesses care about consumer demand curves
because they reveal how much a consumer is
willing to pay for a product. Governments also
care about consumer preferences and demands.

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Basket (bundle) A combination of goods and services that
an individual might consume.

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Consumer preferences Indications of how a consumer would
rank (compare the desirability of) any two possible baskets,
assuming the baskets were available to the consumer at no
cost.

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 1. Preferences are complete
She prefers basket A to basket B (written A >B).
She prefers basket B to basket A (written B >A).
She is indifferent between, or equally happy with, baskets A and B
(written A≈ B).

≈
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*Consumers behave rationally under most circumstances

 2. Preferences are transitive
If A >B and if B >E, then A >E.

IF and

then

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*Consumers behave rationally under most circumstances

 3. More is better

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*Consumers behave rationally under most circumstances

» A function that measures the level of satisfaction a
consumer receives from any basket of goods and
services.
» Lets consider U(y)= 𝑥

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» The rate at which total utility changes as the level
of consumption rises.(how the level of satisfaction
will change (∆U) in response to a change in the
level of consumption (∆y))
∆U
» 𝑴𝑼𝒚 =
∆y

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Total utility and marginal utility cannot be plotted
on the same graph.
The horizontal axes in the two panels are the same (both representing
the number of hamburgers consumed each week, y), but the vertical
axes in the two graphs are not the same. Total utility has the dimensions
of U (whatever that may be), while marginal utility has the dimensions of
utility per hamburger (U divided by y). Therefore, the curves
representing total utility and marginal utility must be drawn on two
different graphs.

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 The marginal utility is the slope of the
(total) utility function.
The slope at any point on the total utility curve is
∆Uൗ the rate of change in total utility at that
∆𝑦
point as consumption rises or falls, which is what
marginal utility measures (note that at any point is
also the slope of the line segment tangent to the
utility curve at that point

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 The relationship between total and
marginal functions holds for other
measures in economics.
The value of a marginal function is often
simply the slope of the corresponding
total function.

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The principle that after some point, as
consumption of a good increases, the
marginal utility of that good will begin to
fall.

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Let x measure the number of units of food and y measure
the number of units of clothing purchased each month.
Further, suppose that Adam’s utility for any basket (x, y) is
measured by U= 𝑥𝑦

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The marginal utility of any one good is the rate at
which total utility changes as the level of
consumption of that good rises, holding constant
the levels of consumption of all other goods.

∆𝑼
MUx= , y is held constant
∆𝒙

∆𝑼
MUy= , x is held constant
∆𝒚

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Let’s look at a utility function that satisfies the assumptions
that more is better and that marginal utilities are diminishing.
Suppose a consumer’s preferences between food and clothing
can be represented by the utility function U= 𝒙𝒚 , where x
measures the number of units of food and y the number of
units of clothing, and the marginal utilities for x and y are
expressed by the following equations:
𝒚 𝒙
MUx= and MUy=
(𝟐 𝒙) (𝟐 𝒚)

Problem
(a) Show that a consumer with this utility function believes
that more is better for each good.

(b) Show that the marginal utility of food is diminishing and

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that the marginal utility of clothing is diminishing.
Solution
(a) Show that a consumer with this utility function
believes that more is better for each good.

By examining the utility function, we can see that U

increases whenever x or y increases. This means that
the consumer likes more of each good. Note that we
can also see that more is better for each good by
looking at the marginal utilities MUx and MUy, which
must always be positive because the square roots of x
and y must always be positive (all square roots are
positive numbers). This means the consumer’s utility
always increases when he purchases more food and/or
clothing.
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Solution
(b) Show that the marginal utility of food is diminishing
and that the marginal utility of clothing is diminishing.

In both marginal utility functions, as the value of the

denominator increases (holding the numerator
constant), the marginal utility diminishes. Thus, MUx
and MUy are both diminishing.

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A curve connecting a set of consumption
baskets that yield the same level of
satisfaction to the consumer.

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it shows a set of indifference curves

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1. When the consumer likes both goods (i.e., when
MUx and MUy are both positive), all the indifference
curves have a negative slope.

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2. Indifference curves cannot intersect.

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3. Every consumption basket lies on one and
only one indifference curve.

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4. Indifference curves are not “thick.’’

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The rate at which the consumer will give up one
good to get more of another, holding the level of
utility constant.

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On a graph with x on the horizontal axis and y on the
vertical axis, MRSx, y at any point is the negative of
the slope of the indifference curve at that point.

The marginal rate of substitution for any basket is a

ratio of the marginal utilities of the goods in that
basket

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Suppose the consumer changes the level of consumption of ∆x and
∆y by x and y, respectively. The corresponding impact on utility ∆U
will be
∆U=MUx(∆x)+Muy(∆y)

But it must be that ∆U=0, because changes in x and y that move us

along the indifference curve U0 must keep utility unchanged.
∆𝒚 𝑴𝑼𝒙
, ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑐𝑜𝑛𝑠𝑡𝑎𝑛𝑡 = −
∆𝒙 𝑴𝑼𝒚
Finally, since MRSx, y is the negative of the slope of the indifference
curve, we observe that

∆𝒚 𝑴𝑼𝒙
- , ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑐𝑜𝑛𝑠𝑡𝑎𝑛𝑡 = = 𝑴𝑹𝑺𝒙, 𝒚
∆𝒙 𝑴𝑼𝒚
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A feature of consumer preferences for which
the marginal rate of substitution of one good
for another good diminishes as the
consumption of the first good increases along
an indifference curve.

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Suppose a consumer has preferences between two goods that
can be represented by the utility function U =xy. For this utility
function, MUx= y and MUy=x6

Problem
(a) On a graph, draw the indifference curve associated with the
utility level U1=128. Then answer the following questions:
1. Does the indifference curve intersect either axis?
2. Does the shape of the indifference curve indicate that MRSx,
y is diminishing?

(b) On the same graph draw a second indifference curve,

U2=200. Show how MRSx, y depends on x and y, and use this
information to determine if MRSx, y is diminishing for this
utility function.
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Solution
(a) To draw the indifference curve U1=128 for the utility
function U =xy, we plot points where xy =128—for example,
point G(x =8, y=16), point H(x=16, y=8), and point I(x=32,
y=4)—and then connect these points with a smooth line.

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Solution
(a)
Can the indifference curve U1 intersect either axis?
Since U1 is positive, x and y must both be positive (assuming
the consumer is buying positive amounts of both goods). If U1
intersected the x axis, the value of y at that point would be
zero; similarly, if U1 intersected the y axis, the value of x at
that point would be zero. If either x or y were zero, the value
of U1 would also be zero, not 128. Therefore, the indifference
curve U1 cannot intersect either axis.

Is MRSx,y diminishing for U1?

Graph shows that U1 is bowed in toward the origin; therefore,
MRSx,y is diminishing for U1.
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*Perfect substitutes
*Perfect complements
*Cobb-Douglas utility function
*Quasilinear utility function

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(in consumption) Two goods such that the
marginal rate of substitution of one good for
the other is constant; therefore, the
indifference curves are straight lines.

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(in consumption) Two goods that the consumer
always wants to consume in fixed proportion to
each other.

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A function of the form U=Axα yᵝ , where U measures the
consumer’s utility from x units of one good and y units of
another good and where A, α , and β are positive constants.

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• The marginal utilities are positive for both goods.
The marginal utilities are MUx= αAxα-1yᵝ and MUy=
βAx α y ᵝ-1; thus, both MUx and MUy are positive
when A, α, and β are positive constants. This means
that “the more is better” assumption is satisfied.

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• Since the marginal utilities are both positive, the
indifference curves will be downward sloping.

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• The Cobb–Douglas utility function also exhibits a
diminishing marginal rate of substitution.

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A utility function that is linear in at least one of the goods
consumed, but may be a nonlinear function of the other
good(s)
The equation for a quasilinear utility function is
U(x,y)=v(x)+by, where b is a positive constant and v(x) is a
function that increases in x—that is, the value of v(x)
increases as x increases This utility function is linear in y, but
generally not linear in x. That is why it is called quasilinear.

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For the following sets of goods draw two indifference curves,
U1 and U2, with U2 U1. Draw each graph placing the amount
of the first good on the horizontal axis.

a) Hot dogs and chili (the consumer likes both and has a
diminishing marginal rate of substitution of hot dogs for chili)

Solution:

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b) Sugar and Sweet’N Low (the consumer likes both and
will accept an ounce of Sweet’N Low or an ounce of sugar
with equal satisfaction)

Solution:

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c) Peanut butter and jelly (the consumer likes exactly 2
ounces of peanut butter for every ounce of jelly)

Solution:

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d) Nuts (which the consumer neither likes nor dislikes) and
ice cream (which the consumer likes)

Solution:

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e) Apples (which the consumer likes) and liver (which the
consumer dislikes)

Solution:

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