Chapter 7 Flashcards
The law of diminishing marginal utility:
principle that added satisfaction declines as a consumer
acquires additional units of a given product
Utility
want-satisfying power
Total utility
total amount of satisfaction
Marginal utility
extra satisfaction from consuming one more unit
THE LAW OF DIMINISHING MARGINAL UTILITY
– Since successive units of a good yield smaller and smaller amounts of marginal utility,
– The consumer will buy additional units of a product only if its price falls.
what does the law of diminishing marginal utility explain
Diminishing marginal utility provides a simple rationale for the law of demand.
UTILITY-MAXIMIZING RULE
The consumer’s money income should be allocated so that the last dollar spent on each product purchased yields the same amount of extra (marginal) utility.
UTILITY-MAXIMIZING RULE formula
MU of product A / price of A = MU of product B/ Price of B
UTILITY MAXIMIZATION
- At each step, spend where MU/$ is highest
- In general, if MU/$ is unequal, spending should be
allocated:
– Away from the good where MU/$ is low
– Toward the good where MU/$ is high
iPads
iPads must have had a higher MU/P than for alternative products when it was introduced.
Diamond-water paradox
Why would water, essential to life, be priced below diamonds,
which have much less usefulness?
- water has higher TU, diamonds have low TU
- diamonds have high MU, water has low MU
- this is bc TU = the MU added together and water is consumed in mass amounts
Opportunity cost and time
The theory of consumer choice can be generalized to account for the economic value of time.
– By accounting for the opportunity cost of a consumer’s time, we can explain certain phenomena that are otherwise quite puzzling.
* E.g.Whyexecutivespaymuchmoretotravelthantheaverage person.
Cash and noncash gifts
People generally prefer cash gifts to noncash gifts costing the
same amount.
– Consumers know their own preferences best.
