II. Consumer demand
    A. The rational consumer
1. The budget constraint

    A useful special case BL:
    X = a product of interest
    Y = Ig = $ of income spent on all goods other than X 

    ? How much income are you spending on goods OTHER than X?
    ? And how much income are you spending on X (TEx)

   You can read TEx directly from the vertical axis:
    Whatever income isn't spent on other goods is spent on X
    For any value of X, TEX = I - Ig
    In other words, how far you've moved down your BL to reach your consumption of good X tells you how much income you've used up to buy it, and that's your total expenditure on X (TEx).

    Real world applications (Java)

    2. Consumer preferences and indifference curves (Uo)

    We've set up the consumer's constraints which establish consumption possibilities
    Now we turn to preferences to see what choices the consumer will make

Learning objectives: Diagram and interpret the consumer's indifference curve. Explain the meaning, geometry and formula for the marginal rate of substitution (MRS).

    a. Basic concepts

    Focus is on pure consumption: use it or lose it, but you have free disposability (you can throw away but not sell what you don't consume)

    For any bundles A and B, a consumer is able to decide:
    "I prefer A to B."
    "I prefer B to A."
    "I am indifferent between A and B."

    Consumer preferences are: (1) complete, (2) stable, and (3) transitive (A>B and B>C = A>C)

    Concept related to total utility: Marginal Utility (MU): the increase in total utility due to the consumption of one extra unit of some item, holding all else constant:
    MUx = DU/DX
    MUy = DU/DY

    Example: You consume donuts (D) and milk (M).
    Milk consumption rises with your quantity of donuts fixed

    Property (1) of utility: the MU of any economic good is positive.
    MUi = dU/di > 0 for any good i. (more is better)

   Property (2) of utility: MU falls as consumption rises
    ("law of diminishing marginal utility)."
    dMUi/di = d²U/di² < 0 for any good i.

    As with the budget line for consumer constraints, to illustrate consumer decision-making for more than one item, we need to be able to incorporate consumer utility into our x-y diagram. That's our next step.

    b. Geometry

    Indifference curves: Arise when consumers face a choice and respond, "I don't care which I choose."
    Indifference curve: a set of consumption bundles that a consumer regards as equally desirable.

Example: milk and donuts. Along the indifference curve,    U(M,D) = Uo, where Uo is a constant.     ? Where in the diagram are consumption bundles that you would not like as much as the bundles along Uo?     Bundles below Uo are less desirable to you--they have less of milk and/or donuts than the points along Uo.     Note that a single indifference curve divides up an entire consumption set into more preferred and less preferred consumption bundles.     Indifference map: a set of several indifference curves.

    Utility is a consumer's genuine "real income"
    => all along Uo, real income is constant.
    (The consumer is equally happy even though the consumption bundles and their money costs differ.)

    Examples of indifference curves:
    Worksheet
    Think each case through and don't be surprised if these curves have rather unusual shapes compared to the 'typical' curves we covered in the basic geometry.
    Illustrations of worksheet examples (Java)