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4 UTILITY THEORY

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In this and the succeeding chapters we discuss the theory of the demand side of the market. Our task will be to explain the way the alternatives presented to each consumer by the market determine the way he spends his income and the quantities of each good that he decides to purchase.

In the present chapter a framework is set forth within which individual consumer demand theory intuitively “fits.” This is the notion of marginal utility. It must be stressed that utility theory provides no explanation in terms of any external observable criteria. It merely provides a logical means of mental orderliness in bringing coherence into a description of individual behavior. It provides a framework by which an internal consistency can be introduced into the explanation of consumer adjustment to changes in market data. The fact that this framework is intuitively and introspectively valid makes it extremely valuable in explaining the actions of market participants.

This chapter provides the conceptual apparatus that is then put to work in Chapter 5 in interpreting individual allocation of income. In Chapter 6 the analysis is extended to cover the demand for particular commodities as expressed by the market as a whole and as it reacts to given changes. The analysis will be built on the basis of understanding the individual demand behavior of which market demand is itself the resultant. In Chapter 7 we apply our analysis to a market process that might develop in an economy where only consumer goods are bought and sold.

Market Theory and the Price System

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