Chapter 7

# Chapter 7 - CHAPTER Utility and Demand 7 After studying...

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Utility and Demand CHAPTER 7

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After studying this chapter you will be able to Explain what limits a household’s consumption choices Describe preferences using the concept of utility and distinguish between total utility and marginal utility Explain the marginal utility theory of consumer choice Use marginal utility theory to predict the effects of changing prices and incomes Explain the paradox of value
Water, Water, Everywhere Why is water, which is so vital to life, far cheaper than diamonds, which are not essential? Why does a National Football League player, on the average, earn more than 45 times the amount that a child-care worker earns?? This chapter helps you to answer questions such as these.

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The Household’s Budget Consumption Possibilities A household’s consumption possibilities are constrained by its income and the prices of the goods and services it buys. A household has a given amount of income to spend and cannot influence the prices of the goods and services it buys. A household’s budget line describes the limits to a household’s consumption choices.
The Household’s Budget Figure 7.1 shows a budget line for movies and soda. The household can afford all the points on or below the budget line. The household cannot afford the points beyond the budget line.

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The Household’s Budget Relative Price A relative price is the price of one good divided by the price of another good. The price of a movie is \$6 and the price of soda is \$3 a six-pack. So the relative price of a movie is \$6 per movie divided by \$3 per six-pack, which equals 2 six-packs per movie.

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The Household’s Budget A Price Change A change in the price of the good on the x -axis changes the affordable quantity of that good and changes the slope of the budget line. Figure 7.2(a) shows the rotation of a budget line after a change in the relative price of movies.

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Real Income A household’s real income is the household’s income expressed as the quantity of goods that the household can afford to buy. Expressed in terms of soda, Lisa’s real income is 10 six- packs—the maximum quantity of six-packs that she can buy. Lisa’s real income equals her money income (\$30) divided
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## This note was uploaded on 04/29/2009 for the course ECON 103 taught by Professor Holt during the Spring '08 term at George Mason.

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Chapter 7 - CHAPTER Utility and Demand 7 After studying...

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