Chapter 20: Consumer Choice Flashcards
Utility
a measure of the about of satisfaction you get out of doing something
Util
the unit of utility
People want to
maximize their total utility
Formula for Marginal Utility
change in Total Utility/ change in number of units consumed
What can’t you do with Utility
you can’t compare it to someones else, they’re all different scales
Law of Diminishing Marginal Utility
Consume more leads to slower increase in utility
What if MU increases with total consumption
you just continue consuming that good with any other good consumption, but thats not what happens in real life
Water-Dimond Paradox
Diamond Ring & Water Bottle, if you offer one now they will probably pick diamond ring, however if you say that you can never use one for the rest of your life you’d probably pick the water bottle.
Why? (water-diamond paradox)
because TU of water > TU of Diamonds, but MU of diamonds > MU of Water
Market prices reflect marginal valuations
so they correspond to marginal utilities and not total utilities
Consumer choice
limited income necessitates choice
consumers make decisions
purposefully (to maximize total utility)
One good can be ______ for another
substitutes
how do Consumers make decisions
without perfect information, but knowledge and past experience help
When should you stop consuming with only one good
when P=MB
New rule for many goods
equalize the marginal utility on the last dollar spend on each good
when price of something goes up
you buy less of it
changes in behavior =
substation effect + real income effect
“Real” income:
actual things, not money bills
What does price change?
your wealth
Cutting the price of goods in half
doubles your wealth
When prices go up
you buy less stuff
Real income effect is larger for
more expensive goods ( you get more extra wealth if the price of cars if down 5% than if the price of water is down 5%)
price changes will induce you to
substitute/change what you buy
Why does the demand curve slope down: Substitution Effect
as the price of a good falls, consumers real wealth increases so they buy more of that good
Why does the demand curve slope down: Real-Income Effect
as the price of a good falls, consumers real wealth increases so they buy more of that good
Why does the demand curve slope down: Diminishing MU
as the quantity increases, the consumer is willing to pay less for additional units
Which of the following is not one of the basic fundamentals of consumer choice?
a) Limited income forces us to make choices
b) Diminishing marginal utility
c) Only relative prices matter
d) People are willing to pay up to the amount of total utility they will get by consuming a good
e) One good can be substituted for another
Diminishing marginal utility
