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Unformatted text preview: Econ Feb 12th 2008 earn extra credit by turning in an explanation for all the things you got wrong for the first three parts. ON PROB SET 3, PROBLEM NUMBER THREE, CHANGE THE PRICE OF BEER to $1 instead of $2 CHAPTER 7 Consumer Behavior: demand and supply curve: Demand determined by two things: person's taste's or preferences AND their budget BUDGET: budget line- a line that shows all consumption opportunities for a consumer, holding income prices fixed. See beer and happy meal chart. Budget lines are always linear: draw line from point A and point I (all money on one commodity, all money on other, connect two dots) Budget line has negative slope (\). Slope is always equal to the price of the x axis over the price on the y axis. Everything on the line or inside is attainable, anything outside the line is non attainable. CHANGES IN INCOME: Increase in income parallel shift outward Decrease in income parallel shift inward Change in prices (LETTER C IN GRAPH) Utility utility- a fictional measure of wellbeing driven by the consumption of the product to get a demand curve we make two assumptions about people: 1) consumers want to maximize their utility, and 2) "perfect knowledge" Total Utility (TU)- utility measured in units of utility, (units are sometimes called utils) We assume that the total utility curve looks like Graph F (candy cane/ U shape) Utility Schedules reflect the individual's taste and preferences Marginal Utility (MU)- Change in total utility associated with a one-unit change in utility. Assumption that every product in the world and every consumer eventually has diminishing marginal utility. MARGINAL UTILITY is equal to the "change in total utility /(divided by) the change in quantity" (second point minus first in both cases). When graphing marginal utility versus quantity graph half way in between the quantities. MARGINAL UTILITY PER DOLLAR SPENT- marginal utility divided by price Units: MU measured as utils per item.. Price is dollar/item... mu/price is measured in utils/dollar DEMAND Consumers maximize total utility by setting MU/dollars spent, equal for all goods and services: CALLED the equi marginal principal in the book. When MU/price is the same for every product you buy, you make the most for your money. When that's equal it's called the Consumer Equilibrium Consumer Equilibrium- MU per dollar spent is equal across all goods and services. The Diamond/Water Paradox- With diamonds people are lower on the TU graph, so the slope is going up, whereas with water people are usually higher on a TU graph and the slope is not as steep. So therefore even though we need water to live, diamonds have more of desirability than water. In example, P=$5 so q=4, So suppose the price of beer goes from $5 to $10. What this means is that my budget line will be at lower on the Y axis and the same on the X axis. So the utility will be along the new line. New quantity Demanded becomes one or two. Law of Demand- when prices go up quantity demanded goes down, because of the income effect Income Effect- what you were able to achieve went down. Substitution Effect- MU:b/ P:b = MU:mcd/P:mcd..... beer goes up, you substitute mcdonalds for beer, and then your shit is equal. The theory presented is used because it predicts behavior. ...
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