AP Micro Ch 19

Total and marginal utility graphs

(A) as more of a product is consumed, TU increases at a diminishing rate, reaches max, and then declines (B) MU, by definition, reflects the changes in TU. Thus MU diminishes w increase consumption, becomes zero when TU is at max, and is negative when TU declines As shown by shaded rectangles in (A) and (B), MU is the change in TU associated w each additional taco. Or alternatively, each new level of TU is found by adding MU to the preceding level of TU

law of diminishing marginal utility

*added satisfaction declines as a consumer acquires additional units of a given product. Although consumer wants in general may be insatiable, wants for an item can be satisfied* In specific time span over which consumers tastes don't change, consumers can obtain as much of a g/s they can afford. The more they obtain, the less they want. Durable goods for ex - a want for car when one doesn't have one may be strong; but second car desire less intense and gets weaker w more. Unless collectors, even the wealthiest families rarely have more than 12 cars, even if income would allow for more to be bought

prices

*goods are scarce relative to the demand for them, so every good carries a price tag*. We assume price tags not affected by amounts each person buys (*price isn't affected by quantity demanded*). After all, each purchase is a tiny part of total demand. Also limited money means you can't buy everything wanted. (REALITY OF SCARCITY TO CONSUMER) *So consumer must compromise, choosing most satisfying mix of g/s. Different individuals - diff mixes*

Income and substitution effects

*income effect*: impact that a change in price has on a consumers real income and consequently on the quantity demanded of that good. *substitution effect*: impact change in price has on its relative expensiveness and consequently on the quantity demanded. (both show why demand curve is down sloping) so income implies decline in p of product increases consumer income and enables consumer to buy more of that product w fixed money income substitution implies lower price makes a product more attractive and increases willingness to substitute it for other products.

Holly showing, algebraically, utility maximizing rule

Consumer must exhaust available income. Tables show 2 A and 4 B fulfills these conditions in that 8 utils/$1 = 16 utils/$2 (last dollar spent on products A and B) and the consumer's 10 dollars is spent

Inferior options

Holly can obtain other combos of A and B w 10 bucks, but none will yield as great a total as 2 a and 4 b Ex she can get 4 a and 3b for $10. But this yields 93 utils inferior to the max 96. *There are other combos of A and B in which MU of last dollar spend is same for both A and B*. But all such combos are either *unobtainable w limited money* (ex 4 A 5 B) or *do not exhaust her money income* (1 A 2 B) and therefore *don't yield max utility attainable.*

Marginal utility and demand

Law of diminishing marginal utility shows why demand for given product slopes down. *If successive goods give smaller MU, consumer will buy additional units of the product only if the price falls*. Someone buying tacos gets less utility w each so they consumer will choose not to buy more (2 units for ex) at that price ($1 for example). *Would rather spend money on other things giving more or equal utility (not less)* Therefore, additional tacos w less utility are not worth buying unless price declines. (When MU negative, taco bell have to pay you to consume another taco). *so diminishing marginal utility supports idea that price must decrease in order for quantity demanded to increase. Consumers behave in ways that make demand curves slope down*.

Cash and noncash gifts

MU analysis shows us why people prefer cash gifts, bc *noncash gifts may not match recipients preferences and may not add as much as cash to TU*. $100 cash provides more choices bc consumers know what they like. You get gift of 2 dollars or 2 of product a that are 1 dollar each (same monetary value). Noncash has less TU even tho same monetary val. Since noncash gifts are common, a big value of those gifts are lost bc don't match recipients tastes (ex uncle bought 15 dollar book but u could get it for 7.5, so 7.5 or 50% value loss involved). Some loss avoided by creative ways individuals handle the problems. Ex - newlyweds set up registries to show their noncash wants. Also people get cash refunds so they could buy stuff w more utility. Also regifting for ex. All three actions support proposition that *individuals take action to max total utility*.

The diamond water paradox

People like Adam Smith wondering why essential goods lower price than unimportant goods. *Water is in great supply relative to demand and thus very low price per gallon. Diamonds are rare and costly to make, and bc supply is small relative to demand, their price is high per carat.* MU of last unit of water is low. COnsumers respond to very low price of water by using great deal of it. COnsumption expanded until MU, which declines as more water consumed, equals its low price. On other hand few diamonds bought bc of price, meaning MU remains high. So in Eq: MU of water (low)/Price of water (low)=MU of diamonds (high)/Price of diamonds (high) MU for last water low and Mu for last diamond high, but *TU of water is very higher and TU of diamonds is low*. Large utility from water bc a lot consumed. (TU is sum of all these gallons). In contrasts TU from diamonds low bc higher price means less people buying.

If the equation is not fulfilled, then some _____ of the consumers expenditures between A and B (from low to high MU per dollar product) will ________ the consumers TU

REALLOCATION; INCREASE ex- if consumer spent $10 on 4 A and 3 B, we see that ... MU of A (6 utils)/Price of A ($1) *IS LESS THAN* MU of B (18 utils)/Price of B ($2) So last dollar on A gives on 6 utils and B provides 9 utils (18/2). *Consumer can increase total satisfaction by purchasing more b less a*. As dollars reallocated from A to B, *MU per dollar of A increase (lower quantity = more utility) while MU per dollar B decreases (les utility w successive units)*. At some new combo the A and B will equal and equilibrium will be achieved (in this case 2 A 4 B)

Utility is ......

SUBJECTIVE the utility of a product varies per person. Jacked up truck might have more utility to off roaders but little utility to someone unwilling to climb into high car. Eyeglasses more utility to blind person than 2020 vision person

Numerical example

Suppose Holly is analyzing which combo of two products (although the analysis also applies if there are more) should be purchased w her fixed income of 10 bucks. *Holly's preferences for products A and B and their prices are basic data determining combo that will max her utility*. Column 2a shows amount of MU she would derive from each successive unit of A, and column 3a shows same thing for product B. both columns reflect law of diminishing marginal utility which is assumed to begin w the second unit of each product purchased.

DVD's and DVD Players: application

Swift lowering of DVD and players resulted from both price and quality considerations. DVD price decline slightly, DVD player price nosedived. COMPLEMENTARY GOODS. (lower P for players expanded their sales and greatly increased demand for movies). DVD's better quality than VC's (VC and DVD substitutes) and much easier to store. Greater audiovisual experience increases consumer satisfaction (substitution away from VC's toward DVDs) *many consumers concluded DVDs have higher ration of MU to price (=MU/P) than ratios for VC's. Those consumers increased TU by getting DVD's rather than VC's*

Decision making process

Table shows preferences on unit basis and per dollar basis as well as price tags. What combo and order should she use her 10 dollars? Looking at 2b and 3b, we see holly *first spend 2 dollars on first unit of B*, bc its MU per dollar of 12 utils is higher than A's 10 utils. *Second unit indifferent for a and b bc MU is 10 for both* (2nd unit of B or first of A). She buys both (has 2 B's ($2x2=4) and 1 A ($1x1=1) - giving total of 5 dollars spent). *she can spend 5 more to achieve higher TU* *Holly should next spend $2 on 3rd unit of B* bc MU per dollar for third B is 9 compared to 8 for second unit of A. Has 3 B and 1 A and is again *indifferent bc 2nd A and 4th B both 8 utils*. (buys both). Now last dollar spend on each product provides same util per dollar (8) and Holly's 10 bucks exhausted. Utility max of good for holly is 2 A and 4 B. Summarizing 2a and 3a info we see holly gets 18 (10+8) from 2 A and 78 (24+20+18+16) utils for 4 B's. *Her 10 dollars gets 96 utils (18+78)*

Marginal utility per dollar

To see how utility max rule works, we must put MU info from column 2a and 3a into a per dollar spent basis. *Consumer choices influenced not only by extra utility that successive units of product A will yield, but also how many dollars (and therefore how many units of alternative B) she must give up to obtain those added units of A*. Rational customer compare extra utility from each product w added costs (price). Say you like 36 util pizza at 12 dollars and a 24 util movie at 6 dollars. You would buy movie (24 utils/$6 is 4 utils for movie) and (36 utils/$12 is 3 utils for pizza). You could see two movies for $12 (assume MU for second unit 16 utils, TU would be 40 utils - 24+16). *40 utils from two movies are superior to 36 utils from same 12 dollar spending on pizza.* *To make extra utility amount from diff prices goods comparable, MU must be put on per dollar spent basis (column 2b and 3b) dividing MU by prices*

People in other nations feel affluent americans are ____ of food and other material goods but _____ in the use of their time

WASTEFUL, OVERLY ECONOMICAL American who visit developing countries see time is used casually while materials are highly prized and talked about. *These differences are primarily a rational reflection of the fact that higher labor in industrial advanced society gives time a high market value, whereas opposite is true in low income developing country*

Deriving the demand schedule and curve

We can derive single d curve for product b by *considering alternative prices for which b might be sold and determining quantity consumers will purchase. * We already know utiltiy max example where she gets 4 B at $2. So graph that and say it falls to 1$. *MU per dollar will double bc price of B has been halved. * so new MU per dollar price for product B is same as MU in utils for Product B now. *purchases of 2 a and 4 b no longer equilibrium w P change*. New max combo is 4 A and 6 B (using same method as before). So she purchases 6 B when price is $1. We sketch downsloping demand curve from this. Clearly *links the utilitly maxing behavior of a consumer and that person's demand curve for a particular product*

Algebraic restatement

allocation rule says consumer will max satisfaction when she allocates income so that the last dollar spend on product a, the last dollar spend on product b, and so forth, yield EQUAL AMOUNTS of MU. *MU per dollar spent on A is indicated by product a divided by A price, MU per dollar spent on B is MU of B divided by price. our utility maximizing rule merely requires these ratios be equal*.

budget constraint

at any point in time the consumer has a fixed, limited amount of money income. Since consumer supplies finite human and property resources, he or she earns limited income every family faces *budget constraint, even millionaire. More severe for consumer w average income than for a consumer w super high income*

Utility maximization and the demand curve

basic determinants of demand for product are -preferences or tastes -money income -prices of other goods The utility data in the table shows consumer preferences. (continue to assume $10 budget). Concentration on construction of a simple demand curve for product B, we assume price of A (representing "other goods") is still $1

Analyze total and marginal utility graphs

column 2 shows TU associated at each level of consumption, and Column 3 shows MU (change in TU) that results from each successive taco. Starting at origin in 19.1a, observe each of the first 5 units increase TU, but by diminishing amount. TU reaches max w addition of 6 unit and declines MU remains positive but diminishes through the first 5 units (*bc TU increases at declining rate*). MU is 0 for 6th unit (*bc unit doesn't change TU*). MU negative at 7th and beyond units (*TU falling*). Shows law of diminishing demand bc each taco gives less extra utility and fewer utils than preceding taco, as consumers want for taco becomes closer to fulfillment.

The utility maximizing rule and demand curve are logically _______

consistent because MU declines, a lower price is needed to induce consumer to buy more of a particular product

rational behavior

consumer is a rational person who tries to use his or her money income to derive the greatest amount of satisfaction, or utility from it. show *rational behavior when the max total utility, making the most for their money*

theory of consumer behavior

description of how consumers allocate incomes among different goods and services to maximize their well-being in addition to explaining law of demand, idea of diminishing marginal utility explains how customers allocate money incomes among many g/s available to buy

preferences

each consumer has clear-cut preferences for certain of the goods and services that are available in the market. buyers also have good idea how much MU they get from successive unit of products they purchase

By accounting for time, we can explain certain observable phenomena that traditional theory cannot ____

explain. May be rational for unskilled worker or retiree to take bus but corp exec w valuable time find it "cheaper" to fly. Rational for retiree w social security check shopping. Rational for high paid surgeon to buy new computer and take short vacations.

Consumers can fulfill specific wants with succeeding units of a product but that each added unit provides...

less utility than the last unit purchased.

Income and substitution effects with utility max

our analysis of utility maximization does not allow us to sort out income and substitution effect of a change in price on Qd. *But utility max does allow us to understand why Qd of product B rises when price of B falls (price of A staying constant)*. substitution effect: MU of B/P of B did equal MU of A/Price of A. but price change changed it to MU B (16)/P of B (1) IS GREATER than MU A (8 utils)/P of A (1). SO last dollar spent on B now yields more utility (16 utils) than last dollar spent on A (8 utils). *A switching of purchases from A to B needed to restore equilibrium; SUBSTITUTION of now cheaper B for A will occur when price of B drops* income effect: Decline in price 2 to 1 increases her real income. After price change, she could get her original max utility combo for 6 dollars instead of 10. She has 4 left over now to spend on more of A, B or both. *This rise in real income enables her to obtain more of a and b with same $10 of MONEY INCOME. The income effect is extra B she purchases bc decline in price of B raised income*

Utility is difficult to ...

quantify. We assume people can measure satisfaction w units called utils (units of utility). Ex) 100 utils from smoothie and 10 from candy bar. These imaginary units are *convenient for quantifying customer behavior for explanatory purposes. *

diminishing marginal utility provides a simple...

rationale for the law of demand

Total utility and marginal utility

related, but different ideas. *Total Utility* - total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a g/s *Marginal Utility* - EXTRA satisfaction a consumer realizes from an additional unit of the product (ex- from eleventh unit). *MU is the change in TU that results from consumption of one more unit of a product*

utility and usefulness are NOT ...

synonyms. Picasso painting might offer great utility to collectors but useless functionally

Medical care purchases

the method of payment for certain goods and services affects their prices at the time we buy them and significantly changes the amount purchased. People would buy more at lower price. People in US who have health insurance pay a fixed premium once a month that covers say 80% of all health care costs. SO when health care needed, price would only be 20% of actual market price. *When ill, purchase much more health care than you would if you were confronted w full price*. As result, financing health care through insurance is important factor in explaining todays high spending on health care and the historical growth of such spending on % of domestic output Like buffet: if you buy all you can eat buffet meal, you will eat more than if you purchases item by item. You can eat more bc MU is positive and price is zero w more foods.

utility

the want-satisfying power of a good or service. The utility of a good is the satisfaction or pleasure one gets from consuming it

The value of time

theory of consumer behavior generalized to account for econ val of time. *both consumption and production take time; time is a valuable commodity that could make people money in a certain time depending on their skills.* If $6 an hour and you be lazy, there is an opp cost of forgone income where they sacrifice the 6 bucks they could've gotten. Stuck between 4 hour $30 golf and 2 hour $40 concert. Gets $10/hour. Full price of golf is $70 (30 market price plus 40 opp cost). Full price of concert $60 (40 market price and 20 worth ur time). *Contrary to what markets alone indicate, the full price f the concert is really less than of golf* assume MU derived from successive games and concerts are the same, should assume more golf games than concerts bc market price of former (30) lower than concert (40). Taking time into account shows how this is reversed and concert is cheaper.

Utility-Maximizing Rule

to maximize satisfaction, 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* (we call this the utility max rule). Finding specific combo that yields the max utility. When consumer has balanced his or her margins using this rule, there is no incentive to alter the expenditure pattern. *Consumer is in equilibrium and would be worse off - TU decline - if there were alters in the bundle of goods purchased, providing there is no change in taste, income, products, or prices.*

How the water diamond paradox is solved

water has much more TU (roughly, usefulness) than diamonds even though the price of diamonds is a lot higher than water. These relative prices relate to MU, not TU

Step By Step process for maximizing Holly's utility

we assume Holly spends her whole income ($10), neither borrows or saves. However saving can be regarded as commodity that yields utility and can be incorporated into analysis

Consumer choice and budget constraint

we assume that situation for typical customer has following dimensions - rational behavior - preferences - budget constraint - prices