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Chapter 5

Chapter 5 . Consumer Choice & Utility Maximization By Laura Lamb, TRU with some insertions from B runo Fullone, George Brown College. 5.1 Law of Diminishing Marginal Utility. Although consumer wants in general are insatiable, wants for specific commodities can be fulfilled.

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Chapter 5

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  1. Chapter 5 Consumer Choice & Utility Maximization By Laura Lamb, TRU with some insertions from Bruno Fullone, George Brown College

  2. 5.1 Law of Diminishing Marginal Utility • Although consumer wants in general are insatiable, wants for specific commodities can be fulfilled. • The more of a specific product that consumers obtain, the less they will desire more units of that product.

  3. 5.1 Law of Diminishing Marginal Utility Gains in satisfaction decline as additional units are consumed 3

  4. Terminology Utility • utility represents the amount of satisfaction a person gets from consumption of a certain item. Total Utility and Marginal Utility • total utility: total amount of satisfaction • marginal utility:extra satisfaction from consuming one more unit

  5. Referring to the table • Total utility increases as Sam consumes each additional Coke up until ________________. • Although, utility rises at a ______________ rate. • Marginal utility diminishes and then becomes _____________ as the _____Coke is consumed.

  6. 5.2 The Theory of Consumer Choice A Typical Consumer… Exhibits rational behaviour Knows clear-cut preferences Is subject to a budget constraint Responds to price changes 7

  7. Utility-Maximizing Rule The consumer’s money income should be allocated so that the last dollar spent on each product purchased yields the same amount of extra (marginal) utility 8

  8. Algebraic Restatement MU of product B MU of product A = Price of A Price of B

  9. Consumer equilibrium • Consumer behaviour is in equilibrium when utility is “balanced (per dollar) at the margin.”

  10. Daisy will maximize utility when she spends all her income and consumes tacos and movies such that: MU(movies) = MU(tacos) Price per movie price per taco What is Daisy’s utility maximizing combination of goods attainable?

  11. Indifference curves • The concept of utility and consumer equilibrium can be illustrated with indifference curves and a budget line.

  12. The diamond-water paradox Before marginal analysis, economists were puzzled by the fact that some essential goods like water had lower prices than luxuries like diamonds. The paradox is resolved when we look at the abundance of water relative to diamonds.

  13. The value of time • The total price of an item must include the value of the time spent in consuming the product. • When time is considered, consumer behaviour appears to be much more rational.

  14. Cash versus non-cash gifts Non-cash gifts may yield less utility to the receiver than a cash gift of equal monetary value because the non-cash gift may not match the receiver’s preferences.

  15. Insights from Behavioural Economics: How rational are we? In this chapter, we made the assumption that consumers make rational decisions. Behavioural economics is a rising area of study & research in economics and some experimental research in this area shows that people are not always so rational. • Dan Ariely: We’re All Predictably Irrational

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