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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 8qY 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 k Key Questions Assignment 9 - Chapter 7 • • • • Read all of chapter seven Key Question 4 Key Question 5 Read “The Last Word” on Criminal Behaviour and answer # 12.