Monday, October 6, 2008

Chapter 21

Chapter 21 – Consumer Behavior and Utility Maximization

Income and Substitution effect

Income Effect – The effect that as price declines, a consumer’s “real income” increases, their purchasing power increases and therefore the demand for the product also increases

Substitution effect - When the price of a good decreases, it becomes a relatively better buy and thus more attractive to the buyer

The combination of the Income effect and the Substition effect drives the law of demand

Law of Diminishing Marginal Utility – we already studied this – this is the law that as you buy more and more of an item, subsequent purchases are worth less and less

Utility –the want-satisfying power of a good, not necessarily the usefulness (ex Paintings), Utility of goods is much different for different people

It is difficult to quantify (b/c it is subjective) but utils are units of satisfaction

Total Utility and Marginal Utility

Total Utility is the number of utils a consumer derives from a particular number of goods (of the same kind,)

Marginal Utility – the number of extra utils a consumer receives from buying more of something

Marginal Utility, Demand and Elasticity

How does the law of diminishing marginal utility explain why the demand curve for a given product slopes downward?  If the marginal utility of an object decreases, then the things are worth less and less, thus they will be willing to pay less and less for them

Consumer Choice and Budget Constraint

Rational Behavior – People try to maximize their utils of satisfaction from their income

Preferences – Consumers have preferences and know the utility they will get from successive, marginal purchases

Budget Constraint – At any time, the consumer has a limited amount of money to spend

Prices – Goods are scarce relative to the demand for them, so every good carries a price tag

Utility Maximizing rule – The consumer should allocate his or her money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility

Marginal Utility per dollar –to make the amounts of extra utility derived from differently priced goods comparable marginal utilities must be put on a per dollar spent basis

Algebraic restatement: The Marginal utility per dollar spent on A is the MU of the product/price so

(MU of product A)/Price of A = (MU of Product B)/Price B = (MU of Product C)/Price C etc

Utility Maximization and the Demand Curve

Deriving the Demand Schedule and Curve – By looking at the Marginal Utility per dollar data we can find how many items a consumer will purchase at any particular price based on their utility

Income and Substitution effect revisited – Switch between products in order to satisfy the Utility maximizing rule

The Value of Time – Time has a value so when considering the price of goods/services, include the price of the persons time (hourly wage).  For example it makes since for a business executive to fly somewhere  rather than take a bus there because while the cost of the bus may be quite less, the cumulative cost of fare + time spent*hourly wage is much greater for the bus

People eat more at buffet meals because the marginal utility is positive and the price is zero

Budget Curves – The relative amount of two goods that a consumer can buy

Indifference Curves – All the combinations of two products that will yield the same total satisfaction or utility.  They are Downsloping, Convex to the Origin – the slope measures the maginal rate of substitution

If we superimpose the budget line on an indifference map (set of indifference curves that yield different total utilities) The point of tangency between the budget line and one of the indifference curves is the equilibrium position

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