Consumption I: Goods and Utility

 Goods are something that provides its holder some kind of satisfaction, and therefore has a utility. There are different kinds of goods, and different classifications can be arranged and identified. We can differentiate between consumption goods (durable or perishable) and capital goods. Classification depending in responsiveness to incomes changes (normal goods and inferior goods) and to price changes (ordinary goods and Giffen goods) can also be made.

-Normal goods are those whose demand increases due to a rise in income levels, having therefore a positive correlation, which implies that the elasticity of this kind of goods is always higher than 0.  Normal goods are divided in two categories, Superior goods and Necessary goods.

·Superior goods, also known as luxury goods, are those goods that displace the demand of inferior goods after a rise in consumers’ income. They are a kind of normal goods as their demand increases when income does as well, however, the difference is that they occupy the share of inferior goods. The elasticity of this kind of goods is, for this, always higher than 1.

·Necessary goods are those whose demand increases when income does, however the increase in demand is less than proportional to the rise in income. Elasticity of this goods is always between 0 and 1.

-Inferior goods are those whose demand moves in opposite direction to the income variation of consumers. This occurs because consumers’ preferences change to other goods that are more highly regarded.

-Ordinary goods are those goods whose demands move in opposite direction to the price variation. This means an increase in the price of the good will mean a decrease of its demand and the other way around.

-Giffen goods are those goods whose demand moves in the same direction as the price variation, this meaning, raising the price of the good will increase its demand, and the other way around. The explanation to this kind of goods comes from the “Snob Effect”, the more expensive a good is, the less people can afford it, and therefore becoming more precious and highly valued.

Utility is the ‘satisfaction’ we get from using, owning or doing something. It is what allows us to choose between options. This can be plotted on a chart.

A preference function therefore assigns values to the ranking of a set of choices. This is useful as it allows us to see consumer behaviour as a maximisation problem: faced with a set of options and a budget constraint, we will choose what satisfies us most. Utility functions are often expressed as U(x1,x2,x3…) which means that U, our utility, is a function of the quantities of x1, x2 and so on. If A is a basket of goods, and , then U(A)>U(B). That is, if we prefer A to B it is because we derive greater utility from it.

Utility functions follow the same code of conduct, the same axioms, as preferences, because they are simply numerical representations of them. That is, they are transitive, complete, continuous and convex, for the same reasons. Being continuous allows us to differentiate them, and being insatiable allows us to say that:

This means that the more, the better, which is the same as saying that utility functions grow with quantity.

The most important thing to point out is perhaps the fact that utility functions do not assign a numerical value to our preferences. They simply indicate order and magnitude of preference, that is, what we like more and by how much.

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