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ECO 100Y1- LA#5- Class Note- 20111017.docx

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Lecture Assignment #5- Consumer Theory  Utility Theory - Measurable Satisfaction  Indifference Theory- does not require satisfaction to be measurable: rating/ ranking system  Utility theory o Maximizing Utility (Satisfaction) o Satisfaction Measurable “Jollies” o Not worry about budget/ constraint  One good X  Two Goods X+Y Total Utility TU= TU (X) – how much of good x you have Q TU “Jollies” MU 0 0 10 1 10 8 2 18 6 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2 - Marginal Utility (MU) Extra Utility from an extra unit - Equation: MU= ∆TU/∆X - Diminishing Marginal Utility (reasonable: Over a fixed period of time) Demand Schedule for Good X Px Qx $0 6 $1 5 $2 4 $3 3 $4 2 $5 1 $6 0 - Max is 6 because the marginal utility is zero - Reason: Diminishing Marginal Utility Schedule NOT LA #5 - Consumer Surplus- Entire Areas above their price AND below the demand schedule - 4 Unit- No additional Surplus - Demand= ½ (4) ($4) = $8 - P= 6-1Q P=2, What is Cs? - Earliest unit is more valuable Cont.... Two Good Utility ModelTU= TU (x, y) - Read because helps jumping to conclusion MUx, MUy, Px, Py MUx/Px = MUy/Py - Maximize satisfaction - Marginal utility per dollar spent on good x = MU of last dollar spent bit on good y - If not equal, you’re nt satisfying maximize satisfaction - Example:14j/$2 > 4j/$1; 7j/$ > 4j/$ o Buy more x; buy less y o MU of X/ Px = MUy/ Py o Optimal Solution o No better than that o Suppose Px decrease , the LHS? RHS; if that happens, buy more LHS to reduce equality, slope of Dx - MUx/Px= MUy/Py - Qxd – negatively slope o Law of Diminishing Marginal Utility MU Equilibrium Equation MUX/ Px= MUY/ Py Looking at Demand Side.... - Adam Smith “Paradox of Value” – Nations of Wealth -1776 o Value- 2 meaning – value in use or value in exchange o The things which have the greatest value-in-use have frequently little or no value- in- exchange, those which have greater value in exchange have frequently little or no value-in-use  Example: Water- Diamond  Water: Value in exchange (price) is low because marginal utility is high  Diamond: Value of exchange (price) is high because marginal utility is high  Marginal Utility is driving source of th
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