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ECONOMICS 200 PRINCIPLES OF MICROECONOMICS

ECONOMICS 200 PRINCIPLES OF MICROECONOMICS. Professor Lucia F. Dunn Department of Economics. Household Consumption Behavior. Utility and Marginal Utility (1). Utility : Satisfaction or Pleasure; Want-Satisfying Power. Marginal Utility (MU) :

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ECONOMICS 200 PRINCIPLES OF MICROECONOMICS

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  1. ECONOMICS 200 PRINCIPLES OF MICROECONOMICS Professor Lucia F. Dunn Department of Economics

  2. Household Consumption Behavior Utility and Marginal Utility (1) Utility: Satisfaction or Pleasure; Want-Satisfying Power Marginal Utility (MU): The last extra bit of utility a consumer gets from consuming the last extra unit of the item. Water Cheap Paradox: Diamond Expensive

  3. Household Consumption Behavior Utility and Marginal Utility (2) * Value is determined by marginal utility from last unit consumed Law of Diminishing Marginal Utility: The more you consume of a certain good, the less you value additional units of it.

  4. Household Consumption Behavior Cardinal Approach – Exact Numbers - can’t use this with utility Ordinal Approach – Rank Order - this is used with utility • Goal of Consumer: • To maximize total utility

  5. Index of Utility Total Utility Gallons of Water per Month for Consumer A 100 200 300 400 Index of Utility Marginal Utility Gallons of Water per Month for Consumer A 100 200 300 400 Household Consumption Behavior

  6. Household Consumption Behavior Index of Utility Total Utility Gallons of Water Index of Utility Disutility! In this case, we say that an extra unit has “disutility”. Gallons of Water MU

  7. So: where: MUi= MU of a unit of commodity i Pi= Price of good i We will consider two goods only. Rearranging we get: Household Consumption Behavior Condition To Reach Consumer Equilibrium (1) MU per dollar spent on commodity #1 should be the same as the MU per dollar on commodity #2 (and the same for all goods).

  8. Household Consumption Behavior Condition To Reach Consumer Equilibrium (2) Example: Good #1 is Avocado; PA = 60 cents Good #2 is Banana; PB = 20 cents So: So, for the consumer to reach equilibrium we must have:

  9. INTUITIVE REASONING:Intuitively, if an avocado costs 3 times as much as a banana, the last avocado consumed should bring the consumer 3 times the happiness as the last banana.

  10. Household Consumption Behavior If PA increases to 80cents, then: So: • What must consumer do to restore equilibrium? • Can NOT change prices • Must change MU by altering consumption • - Want: MUA/MUB = 4 • - Must either raise numerator or lower denominator

  11. MU MU1 MU2 MU Q Q1 Q2 Household Consumption Behavior If consume MORE of good A, MUA decreases. If consume LESS of good B, MUB increases. Index of Marginal Utility So: When PA goes up, QD of good A should go down. * Hence the Law of Diminishing Marginal Utility is one thing that explains the negative slope of a demand curve.

  12. Summary 3 Things Underlies a Demand Curve 1. The Law of Diminishing Marginal Utility 2. Substitution Effect 3. Income Effect

  13. Consumer Surplus This is a difference between value in use and value in exchange. Market for Ball Point Pens Consumer Surplus! 70c 60c 50c 40c 30c Thousands of Pens per Month 0 1 10 20 40 Consumer Surplus: The difference between what a consumer actually pays for an item and what he would be willing to pay.

  14. Consumer Surplus We Can Measure Consumer Surplus on a Demand Diagram. CS: The area under a demand curve and above the price line.  Area: PoAB A TR: Total Revenue  Area: OPoBQo CS B Po TR 0 Qo

  15. Budget Lines (1) Budget line will let us determine what is feasible for a consumer to purchase given her/his income and the prices of goods. Example: (1) Consumer’s Total Income = $3.00 (2) Price of Avocados = $ .60 (3) Price of Bananas = $ .20 Bananas 15 12 Budget Line 9 Avocados 1 2 5

  16. Budget Lines (2) Get any combination of Bananas and Avocados on or below the budget line. Example: 12 Bananas — 1 Avocado 9 — 2 6 — 3 3 — 4 But, 13 Bananas - 1 Avocado cost $3.20: Not Attainable! So: Budget line shows all the attainable combinations of two goods given the price of the goods and the consumer’s income.

  17. Price Change and Budget Lines CASE 1: If price of banana doubled Bananas Price Increase & Budget Line! 15 5 Avocados

  18. Price Change and Budget Lines CASE 2: If price of avocado doubled Bananas 15 5 Avocados

  19. Price Change and Budget Lines When the price of one good changes relative to the price of another good, we say we have had a change in RELATIVE PRICE. i.e. The Ratio of prices -- has changed.

  20. THANK YOU! HAVE A NICE DAY.

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