Ch.7 Consumer Behavior and Utility Maximization

3 characteristics of utility

"utility" and "usefulness" are not synonymous, utility is subjective, utility is difficult to quantify - utils (units of utility)

The value of time

Consumption and production take time. Time explains certain observable phenomena.

algebraic utility-maximizing rule

MU of product A / Price of A = MU of product B / Price of B (if equation is not fulfilled then some reallocation of consumer's expenditures between A & B will increase the consumer's total utility)

law of diminishing marginal utility

added satisfaction declines as a consumer acquires additional units of a given product (the more of that product they obtain, the less they want more of it)

budget constraint

at any point in time the consumer has a fixed, limited amount of money income.

utility-maximizing rule

consumer allocates his/her money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility

preferences

each consumer has clear-cut preferences for certain of the goods and services that are available in the market. (also have good idea of how much marginal utility they will get)

prices

goods are scarce relative to the demand for them, so every good carries a price tag.

rational behavior

the consumer is a rational person, who tries to use his/her money income to derive the greatest amount of satisfaction, or utility, from it. (max their total utility)

marginal utility

the extra satisfaction a consumer realizes from an additional unit of that product (the change in total utility that results from the consumption of 1 more unit of a product)

substitution effect

the impact that a change in a product's price has on it relative expensiveness and consequently on the quantity demanded (explains why demand curve down sloping)

income effect

the impact that a change in the price of a product has on a consumer's real income and consequently on the quantity demanded of that good (explains why demand curve down sloping)

total utility

the total amount of satisfaction or pleasure a person derives from consuming some specific quantity

Utility

want-satisfying power (the satisfaction/pleasure one gets from consuming a good)

The Diamond-Water Paradox

water is great in supply relative to demand, thus low price per gallon. Diamonds are rare, costly, and small in supply relative to demand, thus high price per carat. Marginal utility of last unit of water consumed is very low. (low price of water = great deal used) Few diamonds are purchased due to high price = marginal utility remains high. MU of water (low) / price of water (low) = MU of diamonds (high) / price of diamonds (high). Total utility of water is high, total utility of diamonds is low. Water has much more total utility (usefulness) than diamonds.