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ECON 2000
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Econ TestChapter 6Every household must make three basic decisions1How much of each product or output to demand2How much labor to supply3How much to spend today and how much to save for tomorrowSeveral factors influence the quantity of a given good or service demanded by a single household1The price of the product2The income available to the household3The households amount of accumulated wealth4The prices of other products available to the household5The households taste and preferences6The households expectations about future income wealth and pricesRecall that demand schedules and demand curves express the relationship between quantity demanded and priceA change in price leads to a movement along a demand curveA change in income in other prices or in preferences shift demand curves to the left or the rightchanges in demandThe Budget ConstraintBudget Constraint the limits imposed on the household choices by income wealth and product pricesOpportunity Set or Choice Set the set of options that is defined and limited by a budget constraintAs long as a household faces a limited budget and all households ultimately dothe real cost of any good or service is the value of the other goods and services that could have been purchased with the same amount of moneyThe real cost is its opportunity cost and opportunity cost is determined by relative pricesIf a price or a set of prices falls but income stays the same the opportunity set gets bigger and the household is better offReal Income set of opportunities to purchase real goods and servicesWhen the price of a good decreases the budget constraint swivels to the right increasing the opportunities available and expanding choice Figure 62 pg 125The Basics of Choice UtilityUtility the satisfaction a product yieldsMarginal Utility MU the additional satisfaction gained by the consumption or use of one more unit of a good or serviceTotal Utility the total amount of satisfaction obtained from the consumption of a good or serviceThe difference between Marginal Utility and Total Utility is the MU comes only from the last unit consumed total utility comes from all units consumedThe Law of Diminishing Marginal Utility the more of any one good consumed in a given period the less satisfaction utility generated by consuming each additional marginal unit of the same goodWhen marginal utility is zero total utility stops risingWhen two activities cost different amounts you must find the marginal utility per dollar spend on each activity The Utility Maximizing Ruleequating the ratio of the marginal utility of a good to its price for all goodsDiminishing Marginal Utility and Downwardsloping demand The concept of diminishing marginal utility leads us to conclude that demand curves slope downwardIncome and Substitution EffectsIncome and substitution effects five an explanation for downwardsloping demand curves that does not rely on the concept of utility or the assumption of diminishing marginal utilityThe Income EffectWe first assume that households confine their choices to products that improve their well being then a decline in the price of a product will make the household unequivocally better offThe Substitution Effect of Price ChangeWhen the price of a product falls that product also becomes relatively cheaperThat it becomes more attractive relative to potential substitutesA fall in the price of product X might cause a household to shift its purchasing pattern away form substitutes toward XThe Substitution EffectWhen the price of a product rises that item becomes more expensive relative to potential substitutes and the household is likely to substitute
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