2ndmidtermsummary - Econ 101 2nd Midterm Objective Review...

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Econ 101 – 2 nd Midterm Objective Review. Chapter 6 – Household Behavior ; Consumer Choice Three basic decisions of the household: How much output do we want? (Demand) How much work do we do? (Labor supply) How much money to spend and save? Determinants of household demand: Product price. Available household income. Household wealth. Prices of other products available to household. Tastes and preferences of household. Household’s expectations about future income, wealth, and prices. Budget constraint is defined by income, wealth, and goods’ prices—it limits households. Income – Limit determined by wage rates and household’s willingness to work. A certain level of pay is established by the market. Members of the household can sometimes decide how long to work. Prices – Limit happens mainly from limits of more than one markets. Households can’t control prices in competitive markets because prices are market-determined. Choices Set is the group of choices that can be done inside a certain budget constraint. Note: The real cost of any good/service is the opportunity cost of the good/service; which is determined by relative costs. Utility is the happiness or usefulness (satisfaction) a product gives when used. Utility varies from person to person. All the utility added up from the use of a product is called total utility . The satisfaction difference between each use of the product (the difference in utility) is called marginal utility.
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Total utility graphs might look like this: Marginal utility graphs might look like this: X=Times of use; Y=Total Utility X=Times of Use; Y=Marginal utility. Note: Greatest marginal utility = most utility for every dollar you spend. That’s why you should choose things in order of higher-to-lower marginal utility.
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We consume up to the point our marginal utility drops to zero. In other words, when Marginal Utility is equal to zero, we no longer demand the good. Therefore, the slope of the demand curve is negative. Income effect occurs when a household buys a product X regularly and that product X’s price decreases over time. It feels like the household suddenly had a little more income. Because of that, more opportunities are open to that household: it can either spend more money to buy more product X or spend the leftover income on other products . Price drops, therefore Real Income seems to rise. Substitution Effect occurs when the price of a good falls and becomes relatively cheaper and becomes better than potential substitutes . If the price of product X falls, households might stop buying as much of product X’s substitutes and buy more of the actual product X. Price drops, therefore Opportunity Cost of product X falls. When the price of something we buy drops, we are better off.
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