ECON101 Chapter Notes - Chapter 8: Prefrontal Cortex, Neuroeconomics, Opportunity Cost
26 Jun 2018
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Econ 101 - Chapter 8: Utility and Demand
Consumption Choices
The consumption choices we make as buyer can be influenced by many factors which can be
summarized under 2 broader categories:
oConsumption possibilities
oPreferences
CONSUMPTION POSSSIBILITIES (CP)
All the things we can afford to buy
Combination of GAS that we can afford are limited by income and the price of GAS
Ex. Spend large portion of income on gym membership so spend little on movies
A Consumer’s Budget Line
Spend on our income we reach the limit to our CP
Budget Line: marks the boundary between those combinations of GAS that a household can
afford to buy and those that it cannot afford to buy
Budget line shows consumption options based on two goods (pg 180 – ex. Budget line for Lisa)
the budget line constrains choices – boundary between affordable and unaffordable
Can afford all the points on and inside the budget line
Cannot afford the points outside the line
Changes in Consumption Possibilities
CP changes when income/price changes
Rise in income – line shifts outward but the slope remains the same
Change in price – changes the slope of the line
Goal: determine the effects of such changes
Budget line shows what is possible
Preferences determine which possibility is chosen
PREFERECENCES
Choices we make depend of preferences (a description of likes and dislikes)
Preferences: economist describe it as the concept of marginal benefit (demand curve) and
marginal cost
Goal of theory of consumer choice: derive the demand curve from a deeper account of how
consumers make their buying plans - explain what determines demand and marginal benefit
Look at utility to understand the problem
Utility: the benefit or satisfaction that a person gets from the consumption of GAS:
Total Utility
Total Utility: the total benefit that a person get from the consumption of all the different GAS
It depends on consumption – more consumption generates more total utility
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Ex. Measure Lisa’s utility using any sale she wants but by giving her a starting point. 1 pop gives
her more utility than 1 movie but her total utility from pop climbs more slowly than her total
utility from movies
Marginal Utility
Marginal Utility: the change in total utility that results from a one unit increase in the quantity
of a good consumed
Ex. Total utility for 2 can of pop 123units. Marginal Utility for 2nd can of pop 48 units (123-75)
Marginal utility is positive but diminishes as the quantity of a good consumed increases
Positive Marginal Utility
oAll the things people enjoy, value and want more of have positive Marginal Utility: total
utility increases as quantity of a good consumed increases
oSome objects can have negative Marginal Utility and lower total utility
Ex. Hard labour and polluted air
Diminishing Marginal Utility
oPrinciple of Diminishing Marginal Utility: the tendency if marginal utility to decrease as
the consumption of a good increases
Graphing Lisa’s Utility
Total utility curves slopes upward
Marginal utility curve slopes downward as she consumes more pop
Utility-Maximising Choice
Consumers want to get the most utility possible from their limited resources so make choices
that maximizes utility
A SPREADSHEET SOLUTION
Make spreadsheet with constraints imposed by the budget and consumer preferences to find
point on budget line that gives maximum attainable utility
Find the Just-Affordable Combinations
Show combination of goods Lisa can afford with her income
On Lisa’s spreadsheet only listed the points on the budget line. She can still obtain utility from
points inside the budget line but the smaller quantities of goods do not maximize her utility
Find the Total Utility From Each Just-Affordable Combination
Find the point where her total utility from movies and pop is the highest. This combination will
maximize her total utility
Consumer Equilibrium
Consumer Equilibrium: consumer has allocated all of his/her available income in the way that
maximizes their utility, given the prices of GAS
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AFSA Education
Economists find the Consumer Equilibrium this way: measured total utility from affordable
combinations
Natural way to find Consumer Equilibrium: use idea that choices are made as the margin
CHOOSING AT THE MARGIN
When we go shopping we don’t do utility calculations but instead make a budget that we think
is best
Allocate budget as best as possible by spending more on one item (something that will make
you better off) and less on another item
Marginal Utility per Dollar
Marginal Utility per Dollar: the marginal utility from a good that results from spending one
more dollar on it
Ex. Gasoline: choose to spend one more/one less dollar at the pump. The increase in total utility
that results from spending one more dollar at the pump is the marginal utility per dollar from
gasoline
When buying a movie ticket we spend the unit price. To determine the Marginal Utility per
Dollar we must divide marginal utility (MU) from the good by its price (P)
Marginal Utility per Dollar = MU/P
By comparing Marginal Utility per Dollar from all the goods a person buys we can determine
whether the budget has been allocated in the way that maximizes total utility
Utility Maximizing Rule
A consumer’s total utility is maximizes by the following rules:
Spend all the Available Income
oMore consumption brings more utility, only those choices that exhaust income can
maximize utility (spend all of income)
Equalize the Marginal Utility per Dollar
oMove dollars to good A from good B if doing so increases the utility from good A by
more than it decreases the utility from good
This increasing utility move is possible if Marginal Utility per Dollar for good A
exceeds that from good B
oBuying more of good A decreases its marginal utility and buying less of good B increases
its marginal utility
oBuying more of good A causes total utility to rise but the gap between the Marginal
Utility per Dollar gets smaller
oWhen enough dollars have been moved from good B to A to make the two Marginal
Utility per Dollar equal , total utility cannot be increased further – total utility is
maximized
find more resources at oneclass.com
find more resources at oneclass.com
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Document Summary
Econ 101 - chapter 8: utility and demand. The consumption choices we make as buyer can be influenced by many factors which can be summarized under 2 broader categories: consumption possibilities, preferences. All the things we can afford to buy. Combination of gas that we can afford are limited by income and the price of gas. Spend large portion of income on gym membership so spend little on movies. Spend on our income we reach the limit to our cp. Budget line: marks the boundary between those combinations of gas that a household can afford to buy and those that it cannot afford to buy. Budget line shows consumption options based on two goods (pg 180 ex. Budget line for lisa) the budget line constrains choices boundary between affordable and unaffordable. Can afford all the points on and inside the budget line. Rise in income line shifts outward but the slope remains the same.
