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Chapter 6

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Michael H O

chapter 6 Notes utility - the satisfaction or well-being that a consumer receives from consuming some good or service total utility - the total satisfaction resulting from the consumption of a given commodity by a consumer marginal utility - the additional satisfaction obtained from consuming one additional unit of a commodity Diminishing Marginal Utility • the utility that any consumer derives from successive units of a particular product consumed over some period of time diminishes as total consumption of the product increases (if the consumption of all other products is unchanged) • This law states that as a person increases consumption of a product - while keeping consumption of other products constant - there is a decline in the marginal utility that person dervices from consuming each additional unit of that product • example: all you can eat buffets. you get a full plate of food and you eat it, and it was very good. Your hunger has been tamed and you know it, but you get another full plate anyway. since you're not as hungry, your enjoyment rates go down. And with each plate you eat, the marginal utility decreases even more. If you kept eating, you'd eventually get sick, providing dissatisfaction, or "did-utility" Maximizing Utility • Question: how can consumers decide to allocate their consumption of Cokes and burritos in such a way as to maximize their utility? • Answer: the utility-maximizing consuer should consume Cokes and burritos to the point at which the marginal utliity per dollar spent on the last Coke is equal to the marginal utility per dollar spent on the last burrito. • a utility maximizing consumer allocaes expenditures so that the utility obtained from the last dollar spent on each product is equal. So when they spend on cokes and burritos, the amount that they spend on both things should equal to the budget constraint. • to find the marginal utility, you divide the utility by what it costs. • let's say coke is X and burritos are represented by Y. MUx/Px=marginal utility of X. MUy/Py = marginal utility of Y. if utility of Coke is 30 and price is 3. then 30/3=10. and Coke: utility is 10 and the price is 1$, then 10/1=10. Therefore the marginal utility from the last dollar spent is equal. • MUx/Px = MUy/Py • We can change the equation to MUx/MUy=Px/Py o the right side of the eq is the relative rpice of the two goods. It is determined by the market and is beyond a consumer's control. o the left side is the relative ability of the two goods to add to the consumer's utility o the marginal utility must be the one to be readjusted to equal the relative prices of x&y, because the prices..the consumer has no control over it, only has control over the marginal. • This theory is used by economists to predict how consumers will behave when faced with such events as changing prices and incomes. • a rise in the price of a priduct with all other determinants of demand held constant leadss each consumer to reduce the quatity demanded of the product. Income and Substitution Effects of Price Changes • real income - income expressed in terms of the purchasing power of money income - the quantity of goods and services that can be purchased with the money income. • substitution effect - increases the quantity demanded of a good whose price has fallen and reduves the quantity demanded of a good whose price has risen. • The income effect - leads to consumers to buy more of a product whose price has fallen, provided that the pridcut is a normal good. o a normal good is used to describe the quantity demanded for a particular good or service. In a change of a level of income, a normal good is one that experiences an increase in demand as the real income of the individual/economy increases. o define a normal good by calculating nicme elasticity of demand. If the coeeficient is positive and lower than one, the good is a normal good. o income effect - the change in the quantity of a good demanded resulting from a change in real income (holding relative prices constant) • putting the income and substitution effect together gives us the reason why the demand curve is negatively sloped. Because a fall in prices will increase the quantity demanded. • a giffen good is a positively sloped demand curve. It is an inferior good for which the income effect outweighs the substitution effect so that the demand curve is positively sloped. (inferior good is a good for which demand declines as the level of income in the economy increases. This occurs when a good has more costly substitutes that see an increase in demand as the society's economy improves. It is anything a consumer would demand less of if they had a higher level of real income.) o giffen good happened in the early 19th century when Sir Robert Giffen saw that when there was a rise in the price of imported wheat led to an increase in the price of bread, members of the british working class increased their consumption of bread, which lead to the positive slope. o a giffen good happens when the good is an inferior good (meaning that a reduction in real income leads to households to purchase more of that good. o second: the good must take a larfe proportion of total household ecpenditure and therefore have a large income effect. Since bread was a dietary staple of the british working classes during the 19th century. A rise in the price of bread would therefore cause a lrge reduction in people's real income. This could lead people o eat more bread (and less meat) in order to consume enough calories to stay alive. Consumer Surplus • it is the difference between the total value that consumers place on all units consumed of a commodity and the payment that they actually make to purchase that amount of commodity • example: you would normally pay 100$ for gas. But since there's a sale, you only paid 40$. you saved 60$. That 60$ is your consumer surplus. • consumer surplus on each unit consumed is the difference between the market price and the maximum price that the consumer is willing to pay to obtain that unit. • The market demand curve shows the valuation that consumers place on each unit of the product. For any given quantity, the area under the demand curve and above the prive line shows the consumer surplus received from consuming those units. This is represented by the green area in the picture beside. It is above the market price line. Indifference Curves PAGES 139-147 • on an indifferent curve, there are more than one points on the cruve that will give a consumer the same level of utility. These are all combinations of different things that will give the same utility. • any point abOVE AN INDIFFERENCE CURVE IS PREFERRED TO ANY POINT ALONG THAT SAME INDIFFERENCE CURVE; ANY POINT ON THE CURVE IS PREFERRED TO ANY POINT BELOW IT. which simply means that when the points ab
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