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Elasticity Test
• Those students who have not completed their
elasticity test must do so during the period.
• When completed, please submit with your
name written at the top of the first page.
The Theory of Consumer Choice
A Closer Look at Demand
Income and Substitution Effects
• The demand curve slopes downward for two
reasons: income and substitution effects, and
the law of diminishing marginal utility.
• The Income Effect: A lower price increases a
consumers’ real income, enabling them to buy
more.
• Substitution Effect: A lower price increases the
relative attractiveness of a product.
Diminishing Marginal Utility: Video
• http://www.youtube.com/watch?v=KOUJEyy4
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Law of Diminishing Marginal Utility
• The demand curve also slopes downward
because wants, though unlimited in general,
can be satisfied for a particular product.
• Each added unit of a good provides less utility
than the last.
• Utility is the want satisfying power of a good.
It is the pleasure or satisfaction a consumer
obtains.
Utility
• Utility is subjective and difficult to quantify.
• We measure utility in units called utils (units
of utility).
• Individual A might derive 100 utils from
buying an IPhone and 50 from a BlackBerry.
• Individual B might derive 50 utils from an
IPhone and 100 from a BlackBerry.
Total Versus Marginal Utility
• Total Utility is the total amount of satisfaction
derived from a certain quantity of goods.
• Marginal Utility is the extra satisfaction
derived from one extra unit of the good.
• Marginal Utility will be the change in Total
Utility resulting from the consumption of an
extra good.
• Refer to Figure 7-1 on page 158.
Theory of Consumer Choice
• How do you allocate your income among the
millions of goods and services available?
• Typical behaviour has the following
dimensions:
1. Rational behaviour – utility maximizing
2. Preferences – you know what you like
3. Budget constraints – limited by your income
4. Prices – ability to compare products
Utility Maximizing Rule
• To obtain the greatest utility, you must
allocate spending so that the last dollar spent
on each good or service yields the same
marginal utility.
• Think of this like an attempt to reach a
personal utility equilibrium. If there is a
greater incentive to buy something else
instead, you are not maximizing utility.
Table 7-1 Page 162
• Columns A and B reflect the Law of
Diminishing Marginal Utility.
• As rational consumers, we not only care about
the marginal utility, but also the marginal
utility per dollar. This helps us make decisions
about marginal cost (price) versus marginal
benefit (utility).
• If we are rational, we would select the product
with the greater marginal utility per dollar.
Table 7-1 Page 162
• What is the utility maximizing combination of
goods attainable by Holly?
• To find this answer we must begin making
purchases to maximize utility per dollar until
Holly’s income ($10) is exhausted.
• We assume that Holly spends all of her
money, but savings can also realize utility.
Algebraic Restatement
• MU of Product A / Price of A
=
MU of Product B / Price of B
If this is true for the last purchase of each good,
and all of the consumer’s income has either
been spent or saved, utility is maximized.
Summarizing Consumer Equilibrium:
Maximizing Utility
• http://www.youtube.com/watch?v=JiJlZGqZXZ
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Key Questions
Assignment 9 - Chapter 7
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Read all of chapter seven
Key Question 4
Key Question 5
Read “The Last Word” on Criminal Behaviour
and answer # 12.