Fall 2024 Ch6 Behind Demand PDF

Learning Objectives → Use Economic logic to explain the nature of demand curves. → Explain the relationship between marginal utility and prices....

Learning Objectives → Use Economic logic to explain the nature of demand curves. → Explain the relationship between marginal utility and prices. CHAPTER 6: Behind Demand → Describe the rational behavior of maximizing satisfaction. → Understand the concept of diminishing marginal utility. Utility and Marginal Utility → Utility = happiness or satisfaction we get from consuming goods and services. 6.1: Consumer Satisfaction and → For example: Utility ↳ We buy food because we are hungry, and if we eat we will feel better (and live longer). ↳ We go to a movie because we expect to get more enjoyment from the movie than we will get from staying home and watching television or studying—or whatever it is that we would have been doing otherwise. Utility and Marginal Utility Example of Utility → In general, the more of something we consume, the more satisfaction Number of Movies per Week Total Utility we get from it. 0 0 1 12 2 22 → Total utility = The total amount of satisfaction enjoyed from 3 31 consuming a specific amount of a good or service. 4 39 5 46 6 52 7 57 8 61 9 64 10 66  Total Utility Utility and Marginal Utility The total utility curve for movies slopes upward and is concave, rising at a decreasing rate as the quantity seen increases. → Total utility = The total amount of satisfaction enjoyed from consuming a specific amount of a good or service. → Marginal utility (MU) = the additional happiness or satisfaction we get from consuming one more unit of a good or service. Example of Utility / Marginal Utility Example of Utility / Marginal Utility Number of Movies per Total Utility Marginal Utility Number of Movies per Total Utility Marginal Utility Week Week 0 0 0 0 - 1 12 1 12 12 2 22 2 22 10 3 31 3 31 9 4 39 4 39 8 5 46 5 46 7 6 52 6 52 6 7 57 7 57 5 8 61 8 61 4 9 64 9 64 3 10 66 10 66 2 Marginal Utility Law of Diminishing Marginal Utility As the number of movies watched per week increases, marginal utility decreases. Number of Movies per Total Utility Marginal Utility → As you consume more and more of something, eventually the last unit Week consumed will bring you less satisfaction than the unit before. 0 0 - 1 12 12 2 22 10 → Example: 3 31 9 o If you are hungry, an apple in the middle of the afternoon will be nice. 4 39 8 o A second apple would also be good, but probably not as good as the first. 5 46 7 o A third? Well, yes, you might enjoy it, but nowhere near as much as the first. In 6 52 6 fact, it might even make you unhappy. In that case, you certainly would not want 7 57 5 that third apple. 8 61 4 9 64 3 10 66 2  Marginal Utility, Prices, and Income → Assume that there are only two goods and you are spending all your income on these two goods. → Economists assume that most consumers are rational in spending 6.2: Maximizing Satisfaction their incomes and that they try to maximize their total satisfaction. Marginal Utility, Prices, and Income Marginal Utility, Prices, and Income → If two goods cost the same and buying one more of one good provides → Additional satisfaction (marginal utility) must be combined with more satisfaction than buying one more of the other, a rational reality: consumer will be better off if they buy one more of the good providing o What does it cost (prices)? the greater additional satisfaction. o How much money (income) do you have? → In economic terms, the consumer will buy the good with the greater marginal utility. Marginal Utility, Prices, and Income Marginal Utility, Prices, and Income → How would you compare two goods (A and B)? → Budget constraint is the total amount of items you can afford within a current budget. → If the marginal utility of A > marginal utility of B, would you choose to ↳ It illustrates the range of choices available within that budget. consume more A? → Opportunity cost is the amount or item you give up in exchange for → What information would you need? something else. ↳ It is the slope of the budget constraint. o The price of both goods o Income Marginal Utility, Prices, and Income Marginal Utility, Prices, and Income → Budget constraint equation: 𝑃1 · 𝑄1 + 𝑃2 · 𝑄2 = 𝑚 → An indifference curve shows a combination of two goods in various o 𝑃1 is the price (or cost) of the first item quantities that provides equal satisfaction (utility) to an individual. o 𝑃2 is the price (or cost) of the second item → At any point on the curve, the combination of the two will leave the o m is the amount of money available consumer equally well off or equally satisfied—hence indifferent. o 𝑄1 and 𝑄2 represent the quantity of each item you are purchasing o The cost of the total number of item 1 added to the cost of the total number of → Typically, indifference curves are shown convex to the origin, and no item 2 must equal the amount of money or income you have available. two indifference curves ever intersect. Marginal Utility, Prices, and Income Marginal Utility, Prices, and Income → The optimal choice (or optimal bundle) from a combination of goods → For example, suppose you are spending $7 a week on fruit. is attained when all income is spent, and the consumer is on the highest attainable indifference curve. → Apples cost $1 each and plums cost 25 cents. → In other words, the optimal choice is attained when the budget line is → For the price of 1 apple, you could buy 4 plums instead. tangent to the indifference curve. → You are consuming 5 apples and 8 plums (($1 x 5) + ($.25 x 8) = $7) per → It is the utility maximization point. week. Marginal Utility, Prices, and Income Marginal Utility, Prices, and Income → The optimal choice (or optimal bundle) occurs when → Suppose that you enjoy each apple 4 times as much as you enjoy each plum. 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎𝑝𝑝𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑎𝑝𝑝𝑙𝑒𝑠 → = 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑝𝑙𝑢𝑚𝑠 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑝𝑙𝑢𝑚𝑠 → In other words, each apple gives you 4 units of satisfaction and each plum gives you 1 unit of satisfaction. → 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎𝑝𝑝𝑙𝑒𝑠 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑝𝑙𝑢𝑚𝑠 = 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑎𝑝𝑝𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑝𝑙𝑢𝑚𝑠 4 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑠𝑎𝑡𝑖𝑠𝑓𝑎𝑐𝑡𝑖𝑜𝑛 $1 → = 1 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑠𝑎𝑡𝑖𝑠𝑓𝑎𝑐𝑡𝑖𝑜𝑛 $0.25 4 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑠𝑎𝑡𝑖𝑠𝑓𝑎𝑐𝑡𝑖𝑜𝑛 1 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑠𝑎𝑡𝑖𝑠𝑓𝑎𝑐𝑡𝑖𝑜𝑛 → = $1 $0.25 Marginal Utility, Prices, and Income Marginal Utility, Prices, and Income → Now, suppose that you enjoy each apple twice as much as you enjoy → If you give up an apple, in terms of the prices of the fruit, you could each plum. buy 4 plums instead. → In other words, each apple gives you 2 units of satisfaction and each → But let’s look at the utility you would get from this trade. The loss of 1 plum gives you one unit of satisfaction. apple means your utility decreases by 2 units, and the addition of 4 plums increases your utility by 4 units. → So overall, you gain 2 units of satisfaction with this decision. Marginal Utility, Prices, and Income Maximizing Utility 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎𝑝𝑝𝑙𝑒𝑠 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑝𝑙𝑢𝑚𝑠 → = 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑎𝑝𝑝𝑙𝑒𝑠 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑝𝑙𝑢𝑚𝑠 2 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑠𝑎𝑡𝑖𝑠𝑓𝑎𝑐𝑡𝑖𝑜𝑛 1 𝑢𝑛𝑖𝑡 𝑜𝑓 𝑠𝑎𝑡𝑖𝑠𝑓𝑎𝑐𝑡𝑖𝑜𝑛 → < $1 $0.25 → 2