Elasticity Test Those students who have not completed their elasticity test must do so during the period. When completed, please submit with your name written at the top of the first page.

The Theory of Consumer Choice A Closer Look at Demand

Income and Substitution Effects The demand curve slopes downward for two reasons: income and substitution effects, and the law of diminishing marginal utility. The Income Effect: A lower price increases a consumers’ real income, enabling them to buy more. Substitution Effect: A lower price increases the relative attractiveness of a product.

Diminishing Marginal Utility: Video http://www.youtube.com/watch?v=KOUJEyy48qY

Law of Diminishing Marginal Utility The demand curve also slopes downward because wants, though unlimited in general, can be satisfied for a particular product. Each added unit of a good provides less utility than the last. Utility is the want satisfying power of a good. It is the pleasure or satisfaction a consumer obtains.

Utility Utility is subjective and difficult to quantify. We measure utility in units called utils (units of utility). Individual A might derive 100 utils from buying an IPhone and 50 from a BlackBerry. Individual B might derive 50 utils from an IPhone and 100 from a BlackBerry.

Total Versus Marginal Utility Total Utility is the total amount of satisfaction derived from a certain quantity of goods. Marginal Utility is the extra satisfaction derived from one extra unit of the good. Marginal Utility will be the change in Total Utility resulting from the consumption of an extra good. Refer to Figure 7-1 on page 158.

Theory of Consumer Choice How do you allocate your income among the millions of goods and services available? Typical behaviour has the following dimensions: Rational behaviour – utility maximizing Preferences – you know what you like Budget constraints – limited by your income Prices – ability to compare products

Utility Maximizing Rule To obtain the greatest utility, you must allocate spending so that the last dollar spent on each good or service yields the same marginal utility. Think of this like an attempt to reach a personal utility equilibrium. If there is a greater incentive to buy something else instead, you are not maximizing utility.

Table 7-1 Page 162 Columns A and B reflect the Law of Diminishing Marginal Utility. As rational consumers, we not only care about the marginal utility, but also the marginal utility per dollar. This helps us make decisions about marginal cost (price) versus marginal benefit (utility). If we are rational, we would select the product with the greater marginal utility per dollar.

Table 7-1 Page 162 What is the utility maximizing combination of goods attainable by Holly? To find this answer we must begin making purchases to maximize utility per dollar until Holly’s income ($10) is exhausted. We assume that Holly spends all of her money, but savings can also realize utility.

Algebraic Restatement MU of Product A / Price of A = MU of Product B / Price of B If this is true for the last purchase of each good, and all of the consumer’s income has either been spent or saved, utility is maximized.

Summarizing Consumer Equilibrium: Maximizing Utility http://www.youtube.com/watch?v=JiJlZGqZXZk

Key Questions Assignment 9 - Chapter 7 Read all of chapter seven Key Question 4 Key Question 5 Read “The Last Word” on Criminal Behaviour and answer # 12.