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ECN 104 (388)
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Chapter 5

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ECN 104
Seya Yika

Chapter 5: Consumer Choice and Utility Maximization Law of Diminishing Marginal Utility – added satisfaction declines as consumer acquires additional units of given product. More of a product they obtain, less they want more of it Utility – want satisfying power 1. Utility and Usefulness are not synonymous 2. Utility is subjective (ranges from person to person) 3. Utility is difficult to quantify (assume people measure satisfaction) Total Utility and Marginal Utility Total Utility – total amount of satisfaction derived from consuming specific quantity Marginal Utility – extra satisfaction from consuming one additional unit (change in total utility that results from consumption of one more unit) Marginal Utility and Demand  If successive units yield smaller amounts of utils, consumer will only purchase at price fall (price decrease  QD increase)  If MU falls rapidly for each unit, drop in price needs to be big (inelastic)  Modest declines in MU as consumption increases imply elastic demand Theory of Consumer Choice Assume 1. Consumer us rational and uses income to get greatest amount of satisfaction 2. Consumer has preferences and know how much MU they will get from each unit of an item 3. Consumer has fixed amount of money or Budget Constraint 4. Goods are scarce relative to demand, good carries price Utility-Maximizing Rule  To max. satisfaction, consumers should allocate money income so last dollar spent on each product yields same amount of marginal utility  Balanced Margins  No incentive to alter expenditure pattern  Spend where MU/P is highest  Any other combination yields low satisfaction (inferior option), are unobtainable because of income or do not exhaust her income  Consumer will max satisfaction by allocation money income so last $ spent on A and B yield = MU Utility Maximization and the Demand Curve  Determinants of individual demand are preferences/taste, money income, price of other goods Income and Substitution Effect  Income effect – impact that a change in price of a product has on consumer’s real income and on QD of the good  Sub effect – impact change in product price has on its relative expensiveness and QD Sub effect causes people to want to buy more oranges and increases real income (income effect) allowing her to buy more oranges Indifference Curve Analysis  Cardinal utility – measured utility, to compare costs or revenu
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