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Published byHortense Hopkins Modified over 8 years ago

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Consumer Choice Utility Consumer surplus Budget Constraints Indifference Curves Utility Consumer surplus Budget Constraints Indifference Curves

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I. Utility Analysis what is utility? benefit you get from consuming a good determined by your tastes/preferences (assume these are stable)

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total utility (TU) total benefit from consuming good example total benefit from 3 cookies

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TU increases as consumption increases, to a point < TU 2 cookies TU 3 cookies

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marginal utility (MU) change in TU from consuming one more of a good example how much MORE utility from an additional pack of gum?

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change in TU from 0 to 1 cookie change in TU from 1 cookie to 2 cookies MU of 1 st cookie MU of 2 nd cookie = = 0

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diminishing marginal utility MU falls as consumption rises get sick of cookies

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MU of 1 st cookie > MU of 2 nd cookie 0

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TU cookie TU rises at slower and slower rate as MU declines MU cookie

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How to maximize TU? use available budget equalize MU/$ across goods Huh?

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chose combination of cookies and milk where price of cookiesprice of milk MU cookies = MU milk

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why? chose combo of 6 cookies, 1 milk suppose MU/$1 of cookies = 4, MU/$1 of milk = 15 by consuming fewer cookies, more milk … I would add more to my TU

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TU vs. MU Diamond-Water paradox $10,000 one carat diamond 5 million gallons of tap water

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why? TU of water is greater than TU of diamonds water is essential for life BUT water is abundant, diamonds are rarer MU of last diamond is higher MU determines value

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MU and demand MU declines as consumption rises willing to pay less for each additional unit downward sloping demand

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example : pizza P Q D $10 4 pizzas for 4th pizza willing to pay $10 for 2nd pizza $15 2 pizza willing to pay $15

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II. Consumer Surplus difference between what you pay for a good, any what you are WILLING to pay for a good

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P Q D $10 my demand curve $12 3 my consumer surplus

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P Q D $10 10,000 total consumer surplus area between D and price of pizza

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III. The Budget Line given: consumer ’ s budget prices draw a line representing choices consumption possibilities

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example 2 goods: milk & cookies bottle of milk = $1 cookie = $.50 daily budget = $4

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possible combinations cookies milk 0246802468 4321043210

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budget line milk cookies 8 4 2 6 0 4213

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budget line milk cookies 8 4 2 6 0 4213 Affordable Unaffordable

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what if prices change? changes slope of budget line suppose cookies = $1

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budget line milk cookies 8 4 2 6 0 4213 cookie = $.50 cookie = $1

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what if budget changes budget line shifts suppose budget = $5

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milk cookies budget = $4 budget = $5 8 4 2 6 0 10 42135

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IV. Indifference Curves (appendix) alternative way to show utility curve shows combo of goods that deliver same total utility

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example: milk and cookies milk 8 4 2 6 0 4213 cookies Indifference curve Every point on curve has same total utility

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TU is higher as curve shifts right milk cookies higher TU lower TU

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consumer equilibrium maximize TU stay on budget

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consumer equilibrium cookies 8 milk 4 4 2 best affordable point

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consumer equilibrium cookies 8 milk 4 4 2 best affordable point

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sum it up consumer decisions based on preferences budget constraint consumer decisions made at the margin marginal benefit of one more compared to price of one more

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