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ECO 211 Chapter 8 and 9.pdf

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University of Miami
ECO 211

Chapters 8 and 9 Utility and Demand Why do demand curves slope downward? Because of this notion of utility. Theory of utility comes from philosophers. People behave when they buy goods and services in order to make themselves happy. Utility = happiness or satisfaction Marginal Utility Theory The purpose of marginal utility theory is to explain an individual household’s demand. Marginal utility theory predicts that individual demand curves slope downward. Therefore, market demand curves must also slope downward. Household Consumption Choices Two factors determine a household’s consumption choices: Its budget constraint (how much money it has to spend and the prices of each good or service it buys) Its preferences (how much it likes each good relative to others) Budget Constraint Ahousehold’s consumption choices are constrained by its income and by the prices of the goods and services it buys. The limits to a household’s consumption choices are described by its budget constraint or sometimes called its budget line. Example - Lisa’s Consumption Possibilities Lisa has $30 per month to spend on movies and soda. Movies cost $6 each. If she spends her entire budget on movies, she can see 5 per month. Soda costs $3 per six-pack. If she spends her entire budget on soda, she can drink 10 six-packs a month. Consumption Possibilities Movies ($6) Soda ($3) Expenditure Expenditure Possibility Q (dollars) Q (dollars) a 0 0 10 30 b 1 6 8 24 c 2 12 6 18 d 3 18 4 12 e 4 24 2 6 f 5 30 0 0 Consumption Possibilities Increase in income will shift it to the right Decrease in income will shift it to the left Preferences The combination of goods and services a person chooses to consume from the available choices on the budget line is determined by their likes and dislikes — their preferences. The satisfaction a person gets from consumption is called utility. Lisa’s Preferences How Lisa spends her $30 per month depends on her preferences for movies and soda. Each additional movie or soda she consumes increases her total utility. Utility Is anAbstract Concept We cannot directly observe values for utility. However, each of us knows what we like and what we dislike. We will consume more of the goods and services we like and less of those we dislike. Total Utility Total utility is the total benefit or satisfaction that a person gets from the consumption of goods and services. Total utility depends on the level of consumption — more consumption generally increases total utility. The more you buy of a good, the happier you are. Lisa’s Total Utility The more movies Lisa sees each month, the greater her total utility from movies. The more soda Lisa drinks each month, the greater her total utility from soda. Marginal Utility Marginal utility: change in total utility resulting from a one-unit increase in the quantity of a good consumed. Total Utility and Marginal Utility Diminishing Marginal Utility As c
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