Chapter 4 - Demand - Demand the benefit side of the market...

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Demand: the benefit side of the market – Principles of Economics (Ch.4) 17/11/10 The demand curve is a relationship between the quantity demanded and all costs – monetary and non-monetary – associated with acquiring a good. Law of demand: People do less of what they want to do as the cost of doing it rises. This law is a direct consequence of the cost-benefit-principle as activities should be just pursued as long their benefits exceed or are equal their costs. As soon we have achieved a reasonable level of basic needs (food, shelter, health), we can abandon all references to needs and speak only in terms of wants . The Concept of Utility: This concept represents the satisfaction people derive from their consumption activities. Seeing the consumer as someone whose goal is to maximise the total utility he or she obtained from the goods consumed. Marginal Utility: the additional utility gained from consuming an additional unit of a good. o E.g. total utility per hour 50, 1 in consumption; total Utility per hour 90, 2 in consumption (90-50)/(2-1)=40 (Marginal Utility) o Continuing buying as long marginal benefits/utility is greater than or equal to zero Diminishing Marginal Utility (DMU): the tendency for the additional utility gained from consuming an additional unit of a goods to diminish as consumption increases beyond some point o E.g. one Ferrari makes you happy, two make you even happier, but not twice as much o Does not hold true in general! The rational spending rule: In allocating a fixed income between two goods we generally do better to spend the money on the good whose marginal utility is likely to be higher. Optimal Combination of goods: the affordable combination that yields the highest total utility Rational Spending Rule: spending should be allocated across goods so that marginal utility per euro is the same for each good. MUa / Pa = MUc / Pc o The rational spending rule applies for goods that are perfectly divisional such as milk or petrol o Goods like TVs or bus rides does not satisfy the rule completely as there are whole-number goods o Highlights important roles of income and substitution in explaining differences in consumption patterns (as a price change influences these two and the rational spending rule hast to be adjusted) o Real price matters : the demand for a good falls as the price of a substitutes falls v.v.
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