Key Points

Utility is the want-satisfying capacity of a commodity. A consumer's preferences determine how they rank different bundles of goods to maximize their satisfaction.

Cardinal Utility Analysis assumes utility can be measured in numerical units (utils). Ordinal Utility Analysis assumes utility can only be ranked, without being assigned specific values.

Total Utility (TU) is the total satisfaction from consuming a given quantity of a good. Marginal Utility (MU) is the additional satisfaction gained from consuming one more unit of that good.

This law states that as a consumer consumes more and more units of a commodity, the marginal utility derived from each additional unit declines.

An indifference curve is a graph showing combinations of two goods that give the consumer equal satisfaction and utility. The consumer is indifferent to any combination of goods on the same curve.

MRS is the rate at which a consumer is willing to give up one good for another while maintaining the same level of satisfaction. It is the slope of the indifference curve and diminishes as we move down the curve.

Indifference curves slope downwards, are convex to the origin, a higher curve represents a higher level of satisfaction, and two indifference curves can never intersect.

The budget set includes all bundles of goods a consumer can afford given their income and market prices. The budget line represents the bundles that cost exactly the consumer's entire income.

A consumer is in equilibrium when they maximize their satisfaction, which occurs at the point where the budget line is tangent to the highest possible indifference curve. At this point, MRS equals the price ratio (Px/Py).

Demand refers to the quantity of a good a consumer is willing and able to buy at various prices. The Law of Demand states that, other factors remaining constant, price and quantity demanded have an inverse relationship.

A change in the price of the good itself causes a movement along the demand curve. A change in other factors, such as income or prices of related goods, causes a shift in the entire demand curve.

Normal goods are those for which demand increases as the consumer's income rises. Inferior goods are those for which demand decreases as the consumer's income rises.

Substitutes are goods that can be used in place of each other (e.g., tea and coffee). Complements are goods that are consumed together (e.g., pen and ink).

Market demand for a good is the total demand of all consumers in the market combined. It is calculated by the horizontal summation of individual demand curves.

Price elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its price. It is the percentage change in quantity demanded divided by the percentage change in price.

Demand can be elastic (responsive, |eD| > 1), inelastic (unresponsive, |eD| < 1), or unitary elastic (|eD| = 1). Perfectly inelastic demand has a vertical curve, while perfectly elastic demand has a horizontal curve.

When demand is inelastic, price and total expenditure move in the same direction. When demand is elastic, price and total expenditure move in opposite directions.