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Consumer Behavior & Utility Maximization

Consumer Behavior & Utility Maximization . Chapter 8. Income & Substitution Effects. Income Effect - Impact of a product price change on a consumer’s real income and on quantity demanded.

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Consumer Behavior & Utility Maximization

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  1. Consumer Behavior & Utility Maximization Chapter 8

  2. Income & Substitution Effects • Income Effect- Impact of a product price change on a consumer’s real income and on quantity demanded. • Substitution Effect- Impact of a product price change and your willingness to buy that product as opposed to a substitute item.

  3. Utility • Satisfaction or pleasure one gets from consuming a product. • Utility for a product varies from person to person • Difficult to measure

  4. Total Utility & Marginal Utility • Total Utility- Total amount of satisfaction a person derives from consuming some specific quantity (I.e. 10 units) • Marginal Utility- The extra satisfaction a consumer realizes from an additional unit of that product. (I.e. going from the 10th unit to the 11th the difference between the two).

  5. Key Graph

  6. Law of Diminishing Marginal Utility • Consumers fulfill specific wants with succeeding units of a commodity • Each added unit provides less utility (satisfaction) than the last unit purchased.

  7. Theory of Consumer Behavior • The typical consumers situation has the following dimensions: • Rational behavior • Get most out of their $ • Preferences • Clear-cut preferences for goods/services • Budget constraint • Fixed amount to spend • Prices • Every good carries a price tag

  8. Utility-Maximizing Rule • To maximize satisfaction, the consumer should allocate his or her income so that the last dollar spent on each product yields the same amount of marginal utility. • Marginal Utility per Dollar- Before applying the utility maximizing rule to these data, we must put the MU information on a per-dollar-spent basis

  9. Utility-Maximizing Table (Income = $10 to spend)

  10. Budget Line • Schedule or curve that shows various combinations of two products a consumer can buy with a specific money income. • Characteristics • Income changes • Increase in money income shifts the budget line to the right; decrease to the left. • Price changes • Decline in prices of both products shifts the curve to the right. Increase in prices of both shifts the curve to the left.

  11. Budget Schedule

  12. Indifference Curves • Shows all combinations of two products that will yield the same utility to the consumer

  13. Indifference Schedule

  14. Indifference Map • Series of indifference curves • Each curve reflects a different level of total utility

  15. Consumers Equilibrium Position • Budget Line – Combinations of products a customer can afford • Of these combinations, the consumer would prefer the combination that provides the greatest utility • The equilibrium position is the point that is on the budget line but on the furthest indifference curve

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