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Chapter 6- Consumer Behaviour.docx

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McGill University
Economics (Arts)
ECON 208
Sebastien Forte

Chapter 6: Consumer Behaviour  Utility: the value that you get (it is not an absolute measure)  Utility maximizing consumers adjust their expenditure until the marginal utility per dollar spend is equalized across products  Any change in price generates both an income and a substitution effect  Consumer surplus is the “Bargain” the consumers gets by paying less for the product than the maximum price he or she is willing to pay  Diminishing marginal utility- marginal utility is about that last unit you are consuming  Ceteris paribus, the utility that any consumer derives from successive units of a particular product is assumed to diminish as total consumption of the product increases (we assume your appreciation for it decreases as you have more and more)  Marginal utility (difference) falls as consumption rises  You’re still better off which each successive thing (if it wasn’t getting better you wouldn’t consume it) but the utility decreases with each one  Consumers must decide how to adjust their expenditure to maximize total utility  A utility-maximizing consumer allocates expenditures so that the utility obtained from the last dollar spent on each product is equal  Consider a consumer whose utility from the last dollar spent on Coke is more than from the last dollar spent on burritos. She could increase her total utility by switching a dollar of expenditure from burritos to Coke, and continuing until the marginal utility per dollar spent on Coke equals the marginal utility per dollar spent on burritos.  For 2 products, X and Y, the utility-maximizing condition is: MU X MU Y or MU =xp x p x pY MU =yp Y  Consumer behaviour should satisfy this if people are behaving rationally  In the second equation (above) the consumer is adjusting her consumption (and thus the ratios of MUs in response to changes in relative prices  What happens when there is a change in the product’s pice?  If the price of Coke (X) rises, then at the previous utility-maximizing consumption bundle, we have: MU x p X MU p Y Y  The < shows we are not in equilibrium  As the consumer reduces consumption of Coke, the marginal utility of Coke rises and this increases the ratio on the left hand side of the equation  If they are complementary goods, then if the marginal of coke decreases the marginal utility of burritos would decrease with it (you enjoy it less)  The substitution effect: increases the quantity demanded of a good whose relative price has fallen and reduces the quantity demanded of a good whose (relative) price has increased.  Income effect: for a normal good, the income effect leads consumers to buy more of a product that has fallen in price. For an inferior good, the income effects leads consumers to buy less of a product that has fallen in price  Example: Compare a 10% price reduction of gasoline or a 10% price reduction of coffee. For which would your income effect be larger?
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