1. A2 Economics Mr. Durham durham.j@shishialevel.cn

2. Lesson Objectives
To be able to explain and apply the Equi- Marginal Principle
To be able to explain the law of diminishing MU in deriving an individual demand curve

3. Field Trip(s) Date: October November time period
Period: Friday lunch & afternoon
Assessment: written report
Venue: to be determined

4. Friday – News
Will begin Friday News and tea discussion activities Friday September 15
Once I have received the class list
A sign up sheet to bring a news story will be made available shortly
I will distribute my article and questions to the class in advance of each Fridays class

5. MC Practice
Question
The price of a piece of sushi is $3. Cynthia’s total utility from one piece is 30, and her total utility from 2 pieces is 51, so her marginal utility from the second piece is ______. 17 10 51 7 21
Answer: E

6. HW Check
Marginal Utility Activity
Uploaded to website Friday Sept 01

7. MU & Demand
If: MU were measured in terms of money instead of utils, then the MU curve would be an individual’s demand curve
Measurement in dollars is far more useful
Recall: the definition of quantity demanded
The quantity that a consumer is willing and able to buy at a given price, in a period of time ceteris paribus

8. MU & Demand Quantity Q* gives MU* to the consumer
If the price were > than MU* than the consumer would not be willing to purchase unit Q*
The consumer will continue to purchase up to the point where P = MU

9. MU & Demand All other non-price factors are held constant.
Change in non-price factors will affect the MU for quantity levels
Consumption decisions for more than one good are interconnected

10. Equi-marginal Principle
This extends the law of diminishing Marginal Utility by explaining consumer behavior when distributing their income across different goods and services.
Consumers will allocate more of their income to the goods and services which derive greater utility

11. Equi-Marginal Principle
Principle: That consumers will gain the highest total utility by consuming the combination of goods which ensures that the utility from the last $ spent on each product is equal Formula: MUA/PriceA = MUB/PriceB

12. Video Notetaking: Not necessary.
Raise your hand if you want me to pause

13. MC Practice
Question
Jen likes pizza and hotdogs. If her marginal utility per dollar from pizza is 6 and from hotdogs is 5, Jen __.
is maximizing her total utility
can increase her total utility by buying more hotdogs and less pizza
can increase her total utility by buying more pizza and fewer hotdogs
is maximizing her marginal utility
must increase her income to reach a consumer equilibrium
Answer: C

14. MC Practice
Question
Hank consumes only Mountain Dew and pizza. If Hank decides that the total utility he gets from all amounts of Mountain Dew and pizza is twice what it was before, then Hank’s demand for ________.
each good will not change
one of the goods doubles
each good will halve
one of the goods will have
each good doubles
Answer: A

15. MC Practice
Question
As Betty consumes more of a good, her marginal utility of an additional unit ____, so she is willing to pay ____ for an additional unit of the good.
decreases; less
increases; less
decreases; more
increases; more
does not change; less
Answer: A

16. The Paradox of Value
For centuries, philosophers have been puzzled by the fact that water is vital for life but cheap while diamonds are used only for decoration yet are very expensive. Explain why this is.
You can solve this puzzle by distinguishing between total utility and marginal utility.
Total utility tells us about relative value; marginal utility tells us about relative price.

17. The Paradox of Value
Student Explanation

18. The Paradox of Value
When the high marginal utility of diamonds is divided by the high price of a diamond, the result is a number that equals the low marginal utility of water divided by the low price of water.
The marginal utility per dollar spent is the same for diamonds as for water.

19. Utility & Consumer Efficiency
When a consumer maximizes utility, the consumer is using her or his resources efficiently.
Using what you’ve learned, you can now give the concept of marginal benefit a deeper meaning.
Marginal benefit: is the maximum price a consumer is willing to pay for an extra unit of a good or service when total utility is maximized.
Consumer Surplus
Consumer surplus measures value in excess of the amount paid.

20. Efficiency Price and Value
The demand curve D shows the demand for water.
The demand curve and the supply curve S determine the price of water at PW and the quantity at QW.
The consumer surplus from water is the area of the large green triangle.

21. Paradox of Value Question
One reason why water is cheap compared to diamonds is because the _________.
marginal utility of water is enormous
marginal utility of water is small
total utility of water is enormous
total utility of water is small
total utility of water and diamonds are equal, but the marginal utility of water is much lower than the marginal utility of diamonds
Answer: B

22. Paradox of Value
Question The paradox of value refers to the __________.
utility maximizing rule
fact that water is vital but cheap while diamonds are relatively useless but expensive
fact that consumers have different preferences and utility schedules
law of demand
issue of why the consumer surplus from water equals the consumer surplus from diamonds
Answer: B

23. Downward Sloping D Curve
Recall: AS Econ tells us that 2 effects explain the downward slope of the demand curve
Substitution Effect
Income Effect
Utility theory can explain why this is.

24. Downward Sloping D Curve
Consumers reaction to price changes allow us to trace the demand curve
Example: Mary buys both apples & oranges. Note the amount of apples she buys at different prices
5 at $2 and 12 at $1

25. Downward Sloping D Curve
The combination of apples and oranges before and after the change in the price of apples: * Assumption: Mary has a budget of $20 and will spend it all on the two goods.
Good
Price
Quantity
Cost
Apples $2 5
$10
Oranges $1 10
Good
Price
Quantity
Cost
Apples $1 12
$12
Oranges 8 $8

26. Downward Sloping D Curve
Substitution Effect: apples became relatively cheaper. Before it cost the same to buy 2 pounds of oranges or 1 bag of apples. After, it would cost the same to buy either.
Income Effect: The price change essentially made consumers richer. Before, it cost $20 to buy 5 apples and 10 oranges. After, the same combination cost $15. Purchasing power has increased

27. Downward Sloping D Curve
Distinguish: between the substitution effect and the income effect.
First: look at what the consumer would buy, if we adjust the budget to the amount to buy the original combination.
We will adjust the budget to $15, so Jennifer can buy the original combination of 10 oranges and 5 apples
But she will not actually buy this combination, because the equimarginal formula will not be satisfied

28. Downward Sloping D Curve
Substitution Effect: the change in a consumers consumption of a good in response to a price change
Example – Jennifer responded to the price change by substituting apples for oranges
The MU per dollar she receives from apples is greater than the MU per dollar she receives from oranges.
She will increase consumption of apples and decrease consumption of oranges until;
The MU per dollar is equal for both goods

29. Downward Sloping D Curve
Example – Jennifer increased consumption of apples to 9 and reduced oranges to 6.
Direction of Change
Substitution effect always involves a change in consumption in a direction opposite the price change
Note: We were told that Jennifer now consumes 12 apples. Must also consider the income effect, as the substitution effect only increased the Q to 9

30. Downward Sloping D Curve
After the price reduction, it cost $15 to buy what cost $20 before.
The consumer has, in effect, $5 more than before.
Income is unchanged at $20, but there has been an implicit increase in income
Income Effect: The change in consumption of a good resulting from the implicit change in income because of a price change.
Example: Jennifer used her implicit increase in income to purchase 3 more apples and 2 more oranges.

31. Downward Sloping D Curve
See: The change in Qdemanded is a result of both effects, 4 units from substitution effect, and 3 units from Income Effect.

32. Income Effect The income effect can be positive or negative
The nature of the income effect of a price change depends on whether the good is normal or inferior.
Rule: The income effect reinforces the substitution effect in the case of normal goods; and works in the opposite direction for inferior goods.
Example: What kind of good were apples then, for Jennifer?

33. Inferior Good

34. Past FRQ Choice is an essential part of the analysis in economic texts
Explain how economic analysis suggests that consumers make a choice when buying products and how they react to price changes (12 points)

35. Homework Complete Equi-Marginal Activity Question
Will be uploaded to wikispaces page
2 Extension questions for “extra” practice
Please bring your written solutions to my attention should you choose to answer these.
Next Topic: Budget Lines & Indifference Curves

36. Downward Sloping D Curve
Extra Question: Jennifer has an entertainment budget of $200 per semester, which she divides among purchasing CDs, going to concerts, eating in restaurants, and so forth. When the price of CDs fell from $20 to $10, her purchases rose from 5 per semester to 10 per semester. When asked how many she would have bought if her budget constraint were $150 (since with $150 she could continue to buy 5 CDs and as before still have $100 for spending on other items), she said she would have bought 8 CDs. What is the size of her substitution effect? Her income effect? Are CDs normal or inferior for her?

37. Downward Sloping D Curve
Extra Question: The fact that income and substitution effects move in opposite directions in the case of inferior goods raises a tantalizing possibility: What if the income effect were the stronger of the two? Could demand curves be upward sloping?