Chapter 6: Consumer Choice and Utility Maximization

Income Effect

A change in the price of a product changes a consumer's real income (purchasing power) and thus the quantity of the product purchased.

Substitution Effect

A change in the price of a product changes the relative expensiveness of that product hence changes the consumer's willingness to buy it rather than other goods.

Loss Averse

A characteristic that makes losses feel more intense than the pleasure generated by gains.

Prospect Theory

An explanation of how consumers plan for and deal with life's ups and downs, as well as of why they often appear narrow minded and fail to "see the big picture".

Law of Diminishing Marginal Utility

As a consumer increases consumption of a good or service, the marginal utility obtained from each additional unit of good or service decreases.

Framing Effects

Changes in people's preferences that are caused by new information that alters the frame used to define whether situations are gains or losses.

Rational Behaviour

Human behaviour that seeks to maximize total utility.

Behavioural Economics

The branch of economics that combines insights from economics, psychology, and neuroscience to better the understand those situations in which actual choice behaviour deviates from the predictions made by earlier theories.

Endowment Effect

The tendency that people have to put a higher valuation on anything that they currently process (are endowed with) than on identical items that they do not.

Status Quo

The current situation from which gains and losses are calculated.

Marginal Utility

The extra utility a consumer obtains from the consumption of one additional unit of a product.

Anchoring

The idea that irrelevant information can unconsciously influence people's feelings about the status quo.

Mental Accounting

The idea that people sometimes look at consumption options in isolation, thereby irrationally failing to look at all of their options simultaneously.

Budget Constraint

The limit that a consumer's income (and the prices that must be paid for goods and services) imposes on the ability of that consumer to obtain goods and services.

Total Utility

The total amount of satisfaction derived from the consumption of a single product or a combination of products.

Utility-Maximizing Rule

To obtain the greatest utility, the consumer should allocate money income so that the last dollar spent on each good or service yields the same marginal utility.