Topic05 - The law of demand 5. Demand and Consumer Choice...

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1 5. Demand and Consumer Choice The law of demand ± The quantity demanded of a good or service declines as its price rises and increases as its price falls, ceteris paribus . The law of demand ± The benefit of an activity equals the highest price we’d be willing to pay to pursue it (i.e. the reservation price). ± As the cost of an activity rises and exceeds the reservation price, less of the activity will be pursued. The law of demand ± The origins of demand ² What determines ‘tastes’ or ‘preferences’? ³ Biology ³ Culture ³ Peer influences Translating wants into demand ± How should we allocate our incomes among the various goods and services that are available? Translating wants into demand ± Measuring wants: The concept of utility ² Utility ³ The satisfaction people derive from their consumption activities. ² Assumption ³ People allocate their income to maximise their satisfaction or total utility.
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2 Translating wants into demand ± How much of a free good should we use? ² How many free sausages will an individual want to consume? Alice’s total utility from sausage consumption Sausage quantity (sausages/hour) Total utility (utils/hour) 00 15 0 29 0 31 2 0 41 4 0 51 5 0 61 4 0 How many sausages should Alice consume if the sausage is ‘ free ’? Alice’s total utility from sausage consumption Sausages/hour Utils/hour 13 4 5 6 0 2 150 140 120 90 50 Alice’s total utility and marginal utility from sausage consumption Sausage quantity Total utility Marginal utility (sausages/hour) (utils/hour) (utils/sausage) 0 0 2 0 4 0 5 0 4 0 50 40 30 20 10 -10 __ Alice’s marginal utility Diminishing marginal utility Sausages/hour Utils/sausage 4.5 0 1.5 0.5 4 3.5 2.5 2 50 40 30 20 10 Translating wants into demand ± The law of diminishing marginal utility ³ The tendency for the additional utility gained from consuming an
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This note was uploaded on 08/29/2011 for the course ECON 1101 taught by Professor Janegoley during the Three '08 term at Australian National University.

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Topic05 - The law of demand 5. Demand and Consumer Choice...

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