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Chapter 6

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Department
Economics
Course
ECON 110
Professor
Ian James Cromb
Semester
Fall

Description
Chapter Six: Consumer Behaviour Marginal Utility and Consumer Choice  Economist assume that in making their choices, consumers are motivated to maximize their utility  The satisfaction/well-being that a consumer receives from a good/service  Possible to construct a theory in consumer behaviour based on utility maximization  Must be able to distinguish between o Total Utility: The total satisfaction resulting from the consumption of a given commodity by a consumer, and o Marginal Utility: The additional satisfaction obtained from consuming one additional unit of a commodity Diminishing Marginal Utility  A central hypothesis of utility theory (law of diminishing marginal utility) is; o The utility that any consumer derives from successive units of a particular product consumed over some period of time diminishes as the total consumption of the product increases (if consumption of other products is unchanged) Utility Schedules and Graphs  We make the assumption that utility can be measured, and thus can be compared o This allows us to see the difference between total and marginal utility o As we consume more of a product, total utility rises however the utility that you get from each additional product (marginal utility) is less than the previous one Maximizing Utility  This is the assumption that consumers try to make themselves as well off as they can in the circumstances in which they find themselves – income and market prices The Consumer Decision – ex. on page 123 & 124  To maximize utility, the consumer should consume products until the marginal utility per dollar of one good is equal to the marginal utility per dollar of another good o A utility-maximizing consumer allocates expenditures so that the utility obtained from the last dollar spent on each product is equal o Keep “switching” expenditure from one product to another until the marginal utilities per dollar on each good is the same (get less of one & more of the other) Is this Realistic?  Not many people are willing to stand in the store and compute these ratios to max utility  However, this theory is used by economists to predict how consumers will bejave when faced with such events as changing prices and incomes o If consumers continue to try their best with their resources, the actual thought process not important - try to discover implications of their maximizing behaviour The Consumer’s Demand Curve  Must as what happens when there is change in price in order to derive this demand curve  As a rise in the price of a product (everything else constant) leads each consumer to reduce the quantity demanded of the product o Numerator on left side is bigger – because of diminishing M.U. we need to reduce the quantity consumed so that the M.U. for each unit of good increases Income and Substitution Effects on Price Changes  Can be used to think about the slope of a market demand curve o The fall of one good’s price (everything being equal) affects the curve in two ways  First, incentive to buy more (more demand) creates substitute. Second, the price has fallen which gives consumers more real income to spend o Real Income: Income expressed in terms of the purchasing power of money income – that is, the quantity of goods and services that can be purchased with the money income The Substitution Effect  This effect increases the quantity demanded of a good whose price has fallen and reduces the quantity demanded of a good whose price has risen  To maximize utility after a price drop, you must increase your consumption of that good o In other words, you must substitute away from other goods and toward that one  Substitution Effect: The change in quantity of a good demanded resulting from a change in its relative price (holding real income constant)  See the effect of relative price change by holding purchasing power constant The Income Effect  Income Effect: The change in the quantity of a good resulting from a change in real income (holding relative prices constant)  The income effect leads consumers to buy more of a product whose price has fallen, provided that the product is a normal good  See the effect of the change of purchasing
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