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Chapter 8

ECON 1050 Chapter 8: Econ 1050 Chapter 8 Utility and Demand

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ECON 1050
Eveline Adomait

Chapter 8 Utility and Demand Consumption Choices  The choices you make as a buyer of goods and services are influenced by many factors o Consumption Possibilities  Consumption possibilities are all the things that you can afford to buy. Everything you can buy is limited by your income and by the prices you must pay.  A budget line- marks the boundary between those combinations of goods and services that a household can afford to buy and those that it cannot afford. Fig 8.1 pg 180.  When prices or income change, consumption also changes, a rise in income shifts the budget line outward but leaves the slope unchanged.  A change in price changes the slope of the line. o Preferences  A choice that she makes depending on preference- what she likes and dislikes.  Utility- the benefit or the satisfaction a person gets from the consumption of goods or service.  Total Utility- The benefit that a person gets from the consumption of all the different goods and services. More consumption gives more total utility.  Marginal Utility- The change in total utility that results from a one-unit increase in the quantity of a good consumed.  Marginal utility is positive but It diminishes as the quantity of a good is increased. Some objects have negative utility, hard labour and pollution,: total utility increases as quantity consumed increases.  Diminishing marginal utility-the tendency for marginal utility to decrease as the consumption of a good increases. The principle of diminishing marginal utility. Utility-Maximizing Choice  Consumers want to get the most utility possible from their limited resources. They make choices that maximizes utility.  Spread Sheet solution fig 8.2 pg 183 o Find the just-affordable combinations o Find the total utility for each just-affordable combination  Adding both utilities from each activity or product. By doing this you can find the combination that will maximize total utility. o Consumer Equilibrium  Consumer Equilibrium- is a situation in which a consumer has allocated all of his or her available income in a way that maximizes his or her utility, given the price of goods or services.  To find consumer equilibrium you select the combination that gives the highest total utility. Choosing at the Margin  Allocating your budget the best way possible.  Marginal Utility per Dollar o Economists interpret your best possible choice by using the idea of marginal utility per dollar. o Marginal Utility per dollar is the marginal utility from a good that results from spending one more dollar on it. o Using marginal analysis a consumer’s total. o The increase in total utility results from spending one more dollar at the pump is the marginal utility per dollar from gasoline. o Ex to calculate marginal utility per dollar for movies (or pop) you must divide marginal utility from the good by its price o for pop m would be replaced with p o MU= marginal utility P= Price Utility Maxing Rule  A consumers total utility is maximized by following rule: o Spend all the available income  More consumption brings more utility, only those choices that exhaust income can maximize utility. o Equalize the marginal utility per dollar for all goods.  If buying more of good A decrease its MU, and buying less of good B increases its MU, than moving dollars from good A to good B total utility rises. o Marginal Utility is maximized when = The power of Marginal Analysis  THE RULE IS SIMPLE: if marginal utility per dollar from movies exceeds the marginal utility per dollar from pop, see more movies and buy less pop. Revealing Preferences We don’t need to ask Lisa to tell us her preferences We can figure them out for ourselves by observing what she buys at various prices The units in which we measure Lisa’s preferences don’t matter—any arbitrary units will work22222 Lisa’s Preferences When Lisa maximizes her total utility, her marginal utility per dollar from pop equals her marginal utility per dollar from movies MUp/Pp = MUm/Pm Multiply both sides of this equation by the price of pop to obtain MUp=MUm x (Pp/Pm) This equation says that the marginal utility from pop is equal to the marginal utility from movies, multiplied by the ratio of the price of pop to the price of a movie The ratio Pp/Pm is the number of movies that must be forgone to get 2 case of pop (also the opportunity cost of pop) For Lisa, the marginal utility from 6 cases of pop equals ½ of the marginal utility from 2 movies Predictions of Marginal Utility Theory Marginal utility theory predicts the law of demand The theory also predicts that a fall in the price of a substitute of a good decreases the demand for the good and that for a normal good, a rise in income increases demand All these affects are predictions of marginal utility theory To derive these predictions, we study the effects of 3 events •A fall in the price of a movie •A rise in the price of pop •A rise in income A Fall in the Price of a Movie With no change in her $40 income and no change in the price of pop, the price of a movie falls from $8 to $4 Finding the New Quantities of Movies and Pop 3-step calculation 1) Determine the just-affordable combinations of movies and pop at the new prices 2) Calculate the new marginal utilities per dollar from the good whose price has changed 3) Determine the quantities of movies and pop that make their marginal utilities per dollar equal Affordable Combinations The lower price of a movie means that Lisa can afford more movies or more pop Lisa can afford any of the combinations shown in the rows of Table 8.3 New Marginal Utilities Per Dollar From Movies A person’s preferences don’t change just because a price has changed With no change in her preference, Lisa’s marginal utilities in Table 8.3 are the same as those in Table 8.1 Because the price of a movie has changed, the marginal utility per dollar from movies changes The marginal utility per dollar from movies has doubled Equalizing the Marginal Utilities Per Dollar If Lisa sees 6 movies and buys 4 cases of pop a month (row c), her marginal utility per dollar from movies (6 units) equals her marginal utility per dollar from pop and she is maximizing util
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