Economics_Chapter_9_Study_Guide

Economics_Chapter_9_Study_Guide - Karlee Novice Economics...

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Karlee Novice Economics Chapter 9 Study Guide 1) Utility and Consumer Decision Making a) The Economic Model of Consumer Behavior in a Nutshell i) Economic model of consumer behavior predicts that consumers will choose to buy the combination of goods and services that makes them as well off as possible from among all the combinations that their budgets allow them to buy. b) Utility i) Utility is the enjoyment or satisfaction people receive from consuming goods and services ii) The goal of a consumer is to spend available income so as to maximize utility. (1) Difficult to measure utility because there is no way to know exactly how much enjoyment one gets out of a product. iii) Not possible to measure utility compared to others. There are no units for utility. iv) No units to measure utility but it for the economic model it is easier to understand if we assume it can be directly measured. c) The Principle of Diminishing Marginal Utility i) Example: If you go to a party and you are starving and decide to eat a piece of pizza the amount of satisfaction you will get from the first one will be a lot (lets say 20). Every slice of pizza after that will become less and less enjoyable. ii) The graph that demonstrates this is a graph that is increasing at a decreasing rate. iii) Marginal utility (MU) is the change in total utility a person receives form consuming one additional unit of a good or service. (1) Ex: as you increase your consumption from 2 slices to 3 slices, your total utility increases from 36 to 46, so your marginal utility from consuming the third slice is 10. iv) Eventually after consuming too much there will be no more enjoyment and the marginal utility will become negative. v) Law of diminishing marginal utility : Consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time. d) The Rule of Equal Marginal Utility per Dollar Spent i) The key challenge for consumers is to decide how to allocate their limited incomes among all the products they wish to buy. ii) Every consumer has to make trade-offs iii) Budget constraint : The limited amount of income available to consumers to spend on goods and services iv) Optimal decisions are made at the margin. That is, most of the time economic decision makers-consumers, firms and the government-are faced with decisions about whether to do a little more of one thing or a little more of an alternative.
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v) The key to making the best consumption decision is to maximize utility by following the rule of equal marginal utility per dollar : As you decide how to spend your income, you should buy pizza and Coke up to the point where the last slice of pizza purchased and the last cup of Coke purchased give you equal increase in utility per dollar. (1) * You must equalize our marginal utility per dollar spent NOT your
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This note was uploaded on 04/07/2008 for the course ECO 001 taught by Professor Gunter during the Spring '06 term at Lehigh University .

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Economics_Chapter_9_Study_Guide - Karlee Novice Economics...

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