ECO 401 — ADVANCED MICROECONOMICS I: Lecture Note

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LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS Course Code: ECO 401 Course Title: ADVANCED MICROECONOMICS I Course Units: 2 units Consumer Behaviour and Market Optimization Equilibrium Analysis in Single and Multimarket Systems Production Theory, Duality, and Factor Markets Dynamic Consumption, Investment, and Value Theory Efficiency, Equity, and Welfare Economics Series 1: Consumer Behaviour and Market Optimization Part 1: Foundations of Consumer Behaviour • 1.1 The Concept of Consumer Behaviour • 1.2 Preferences and Utility Functions • 1.3 Budget Constraints and Choice Part 2: Optimisation in Consumer Theory • 2.1 The Maximisation Framework: Utility Maximisation • 2.2 The Minimisation Framework: Expenditure Minimisation • 2.3 Duality in Consumer Choice Part 3: Income and Substitution Effects • 3.1 The Slutsky Equation • 3.2 Hicksian Substitution Effect • 3.3 Applications to Consumer Surplus Part 4: Consumer Behaviour under Uncertainty • 4.1 Expected Utility Theory • 4.2 Risk Aversion and Risk Preferences • 4.3 Implications for Market Optimisation Introduction

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS Every day, individuals make choices about what to buy, how much to save, and which products or services to consume. These decisions are not random, but rather guided by preferences, constraints, and the desire to achieve the best possible outcomes. In economics, such behaviour is studied through the lens of consumer theory and optimisation, which provides powerful tools for analysing how people allocate scarce resources. This Series sets the stage for understanding these fundamental ideas, which are central to advanced microeconomics and essential for grasping the broader themes of equilibrium, production, and welfare that will follow in later Series. The aim of this Series is to equip you with the ability to analyse consumer behaviour using optimisation frameworks, to evaluate the effects of income and substitution changes, and to apply these concepts to situations involving uncertainty. By the end of the Series, you should be able to confidently explain and apply the principles that underpin consumer decision-making and market optimisation. We shall commence this Series by examining the foundations of consumer behaviour, focusing on preferences, utility functions, and budget constraints. Then, we will move on to optimisation in consumer theory, where you will study utility maximisation, expenditure minimisation, and the duality of consumer choice. Following that, we will explore income and substitution effects through the Slutsky equation, Hicksian analysis, and their applications to consumer surplus. Finally, the Series will be rounded off with a discussion of consumer behaviour under uncertainty, including expected utility theory, risk preferences, and their implications for market optimisation. Series Learning Outcomes Upon completing this Series, you should be able to: SLO 1.1 define the concept of consumer behaviour and explain how preferences and utility functions shape choices, SLO 1.2 analyse the role of budget constraints in determining consumer decisions, SLO 1.3 apply optimisation frameworks to demonstrate utility maximisation and expenditure minimisation, SLO 1.4 evaluate the duality principle in consumer choice and its implications for market optimisation, SLO 1.5 explain the Slutsky equation and distinguish between income and substitution effects, SLO 1.6 apply Hicksian substitution analysis to assess changes in consumer surplus, SLO 1.7 demonstrate the use of expected utility theory in analysing consumer behaviour under uncertainty, and SLO 1.8 evaluate risk preferences and their impact on consumer decision-making in uncertain market conditions.

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS 1.1 Foundations Of Consumer Behaviour 1.1.1 The concept of consumer behaviour Consumer behaviour refers to the study of how individuals make decisions about what goods and services to purchase, how much to consume, and how they allocate their limited resources. It is concerned with preferences, motivations, and constraints that shape choices. In microeconomics, consumer behaviour provides the basis for analysing demand and market outcomes. Consumers face trade-offs because resources are scarce. For example, choosing between buying a textbook or attending a seminar involves weighing preferences against available income. Economists model these decisions using utility functions and budget constraints. Fill in the blank: Consumer behaviour is the study of how individuals allocate ______ resources to maximise satisfaction.

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS 1.1.2 Preferences and utility functions Preferences describe how consumers rank different bundles of goods and services. They are assumed to be complete (every bundle can be compared), transitive (consistent ranking), and non-satiated (more is preferred to less). A utility function is a mathematical representation of preferences, assigning numerical values to bundles of goods to indicate satisfaction. For example, if a consumer prefers apples to oranges, the utility function will assign a higher value to apples. Utility functions allow economists to model and predict consumer choices. Fill in the blank: A utility function assigns ______ values to bundles of goods to represent satisfaction. ---

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS 1.1.3 Budget constraints and choice A budget constraint represents the combinations of goods and services a consumer can afford given their income and the prices of goods. It is expressed as: P_x \cdot X + P_y \cdot Y = I where P_x and P_y are prices of goods X and Y, and I is income. The consumer’s choice involves selecting the bundle of goods that maximises utility subject to the budget constraint. Graphically, this is shown where the highest attainable indifference curve touches the budget line. Fill in the blank: The point where the highest indifference curve touches the budget line represents the consumer’s ______ choice. --- Pilot questions 1.1 1. Which term describes the ranking of different bundles of goods by consumers? 2. What does a utility function assign to bundles of goods? 3. What is the mathematical expression of a budget constraint with two goods?

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS 4. At what point is consumer equilibrium achieved graphically? 5. Which assumption states that consumers prefer more to less? 1.2 Optimisation In Consumer Theory 1.2.1 The maximisation framework: utility maximisation Utility maximisation is the process by which consumers select the combination of goods and services that provides the highest level of satisfaction, subject to their budget constraint. The consumer seeks the point where the indifference curve is tangent to the budget line, which represents equilibrium. This framework assumes rational behaviour, meaning consumers consistently choose the bundle that maximises their utility. Mathematically, the problem is expressed as: \max U(X,Y) \quad \text{subject to} \quad P_x \cdot X + P_y \cdot Y = I Fill in the blank: Consumer equilibrium occurs where the indifference curve is ______ to the budget line. ---

LA-NET | ONLINE LEARNING VIDEO PLATFORM FOR POST-SECONDARY & HIGHER INSTITUTION STUDENTS 1.2.2 The minimisation framework: expenditure minimisation Expenditure minimisation is the dual problem to utility maximisation. Instead of maximising utility given a budget, the consumer minimises expenditure required to achieve a given level of utility. This approach is useful for deriving demand functions and analysing cost efficiency. The mathematical expression is: \min P_x \cdot X + P_y \cdot Y \quad \text{subject to} \quad U(X,Y) = \bar{U} Fill in the blank: Expenditure minimisation seeks the lowest ______ needed to reach a specified utility level. ---

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