This document summarizes key concepts from a chapter on modeling individual choice, including: 1) It introduces a basic model of how individuals make choices by allocating scarce resources, assuming they are always rational and make the best choice. 2) Key concepts are defined, including total utility, consumption, marginal utility, and diminishing marginal utility. 3) Decision rules are described for situations involving one good without scarcity, multiple choices without scarcity, multiple options with scarcity, production, intertemporal decisions, and decisions involving risk. The general decision rule aims to equalize marginal utility or value across options.

1. Chapter 2: Modeling
Individual Choice
 Purpose: Develop a model to
describe how individuals make
choices (allocate scarce resources).
 Start with a simple model, then adapt
to allow for more complex decisions.
 Assumption that always holds:
Individuals are rational -- always
make best choice.

2. Key Concepts of the
Model
 Total Utility (TU) -- total satisfaction/
happiness
 Consumption -- act of deriving 得到
utility.
 Marginal Utility (MU) -- the change in
TU resulting from a change in the
quantity (Q) consumed (MU = ΔTU/ΔQ).
 Diminishing MU -- an assumption that
utility diminishes with each successive

3. Decision Rule With One
Good (No Scarcity)
 Consume up to the point before total
utility falls (beyond this point will take
away from total utility).
 Decision rule: MU=0 (make decisions
at the margin).
 Referred to as satiation or bliss point.

4. Decision Rule with n
Choices (No Scarcity)
 If money is not scarce, consume until
fully satiated from each choice:
MU1/$=0 and MU2/$=0 and MU3/$=0
and………. and MUn/$=0.
 If time is resource, $ replaced with
unit of time.
 Decision rule:
MU1= MU2=MU3=…….=MUn=0.

5. Decision Rule n
Options and Scarcity
 Must determine optimal allocation --
allocation of resources that
maximizes utility.
 Decision Rule:
MU1/unit = MU2/unit =…..= MUn /unit = X
 Known as Equal Margins Principle --
maximize utility when margins are
equal.

6. Decision Rule With
Production
 Endowment -- our natural productive
resources, such as labor.
 Based on our endowment-- produce to
consume and consume to maximize
utility. Thus, produce to maximize
utility.
 Must decide how to get the most utility
from endowment.

7. Decision Rule With
Production
 Marginal Product (MP) -- change in
output (Q) due to productive resource.
MP (of labor N) = ΔQ/ΔN
o Assume MP diminishes.
 Determine Value of the Marginal
Product (V) -- utility derived from a
successive unit of productive resource.
o Combines MP and MU

8. Decision Rule with
Production (No Scarcity)
 Based on V, must decide when to stop
producing.
 If no scarcity, at the point where no
further utility is derived.
 Decision Rule:
V1= V2= V3=……..= Vn=0

9.  The optimal allocation is reached
when there is no other opportunity
that offers higher utility.
 Decision rule:
V1= V2= V3=………..= Vn=X (X>0)
 If constraints change, must find a
new allocation.
Several Choices,
Production, and Scarcity

10. Decisions with Future
Consequences
 Most important choices are generally
intertemporal-- have consequences
across time, such as going to college.
 Two concepts aid in decisions that
affect our future: Present Value and
Discount rate.

11.  Present Value (P) -- value of future
utility for choices put in a value today--
allows comparisons across time.
 Discount rate (DR)-- a measure of
one’s willingness to wait for utility.
-- Low DR - more willing to wait.
-- High DR - less willing to wait.
 Our discount rates can change.
Decisions with Future
Consequences

12. Decision Rule For
Intertemporal Choices
 Decision rule:
PV1 = PV2 = PV3 =……….= PVn.
-- V: value of marginal product
(utility derived from productive
resources).
-- P: present value (future utility in
today’s value).

13. Adding Risk to the
Decision Rule
 Risks (E) -- events that may affect
one’s decision with some perceived
probability.
 Uncertainty -- events that may affect
one’s decision, but with no perceived
probability.
 Risk enters the decision rule;
uncertainty does not.

14. Adding Risk To the
Decision Rule
 Decision rule:
EPV1 = EPV2 = EPV3 =……= EPVn.
“Expected Present Value”
-- V: value of marginal product (utility
derived from resources).
-- P: present value (today’s value of
our future decisions).
-- E: adjustment for perceived risk.