Ecom- Exam 2 Notes - Chapter 7 Utility Basics Utility...

Chapter 7
Utility Basics
Utility : measure of amount of satisfaction a person derives from something
 Incorporates emotions and sensations
 Cant be compared across individuals
 Rational individuals maximize utility when making choices.
o For example, if playing soccer for the next hour yields more utility than playing baseball, rational
individuals will play soccer.
Utility Function : formula for calculating the total utility that a person derives from consuming a combination of goods and
services
 Utility measurements are relative
 Bundle: unique combination of goods and services
 For example, suppose Sarah receives a utility of 3 for each serving of mac-n-cheese she eats, 2 for broccoli, and 8
for ice cream.
o If she eats 1 serving of mac-n-cheese, 2 servings of broccoli, and 2 of ice cream, then: total utility = (3 x
1) + (2 x 2) + (8 x 2) = 23
Marginal Utility : the change in total utility from consuming an additional unit of a good or service
 Diminishing marginal utility: the additional utility gained from consuming successive units of a good or service
tends to be smaller than the utility gained from the previous unit or service.
 sometimes it becomes negative
Revealed Preferences
Revealed preference: people’s preferences can be determined by observing their choices and behavior
 Utility is hard to measure
Maximizing utility with Constraints
 People have many wants and are constrained by the time and money available to them.
Budget Constraint: provides all possible combinations of goods and services and consumer can buy with a given income
Responding to changes in Income
 When income increases, more bundles of goods/services are affordable
 When income decreases, consumers will have to cut consumption of things
 A change in income is represented by shifting the entire budget line outward
Responding to changes in Prices
 Income effect : occurs as a consumption of changes from increased effective wealth due to a lower price
 Substitution effect: change in consumption that results from a change in the relative price of goods
o The opportunity cost of consuming a good, changes as prices change.
o A price change causes the budget line to rotate.
Utility and Society
 Outside Perception
o What others think of your purchases
o How much others have
 Inward preferences
o How you prefer to spend money
Utility, Altruism, and Reciprocity
 Altruism: a motive for action in which a person’s utility increases simply because someone else’s utility increases.
 Reciprocity : responding to another’s action with a similar action
Example Homework Problems (Chapter 7)