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AP Economics - Chapter 19: Consumer Behavior & Utility Maximization

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Michael Ungar

on 24 September 2018

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Transcript of AP Economics - Chapter 19: Consumer Behavior & Utility Maximization

AP Economics - Chapter 19: Consumer Behavior & Utility Maximization
Opportunity cost
- the thing that must be given up in order to do something else

Example: If Joe wants to continue ice skating for an hour, he must give up an hour he would’ve used to study. The hour of studying is the opportunity cost of ice skating.

Economics
- a science concerned with the process by which goods and services are produced, sold, and bought

a study of choices made to deal with scarcity

the social science that deals with the problem of how to allocate scarce resources between the competing and unlimited wants and needs of people

Normal good
- a good whose demand increases when income increases, and falls when income decreases, but the price stays the same

Example: Clothing would be a normal good because people tend to buy more of it when they have more money, and less when they have less money, although the price of the clothing is not changing


Marginal analysis
- evaluation of additional benefits versus additional cost

Scarcity
- unlimited wants, limited resources

Example: Consumers demand an unlimited amount of fossil fuels, but there is only so much left on earth.

Complement
- a good that is not similar enough to take the place of another good (antonym of substitute)

Examples: boots and laces, flash lights and batteries

The complementary goods have an inverse relationship, so if the price of hotdogs raised to the point no one was purchasing them, people would stop buying the buns


Normal good- a good whose demand increases when income increases, and falls when income decreases, but the price stays the same

Example: Clothing would be a normal good because people tend to buy more of it when they have more money, and less when they have less money, although the price of the clothing is not changing


Inferior good- a type of good whose demand decreases when income increases

Example- Spam is an inferior good because people are less likely to buy Spam after their income increases to the point they could be having lobster instead


goods and services
items and actions that hold value for the consumer
ex. plumbing service, diamond ring
Factors
of
Production
Land
Natural Resources
original fertility and mineral deposits, topography, climate, water, and vegetation
Labor
contribution of humans (workers)
wages
Capital
Manufactured Resources
technology, buildings, machines, equipment
Entrepreneurial
Ability
innovators with ideas, organizing, managing, assembling factors of production
Utility
= is

want satisfying power
.
The utility of a good or service is the satisfaction or pleasure one gets from consuming it.
(Milk - to Dark Chocolate)

The utility of a specific product may vary widely from person to person - measure satisfaction with units called
"utils"
(units of utility).
Total Utility

= is the total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service.
Marginal Utility
= the
extra
satisfaction a
consumer realizes from an additional unit of that product
Law of Diminishing Marginal Utility
-
added satisfaction (utility)
declines
as a consumer acquires additional units of a given product.
How much are you willing to pay for the first
candy bar?
And the Second?
And the Third?
Fourth?
Fifth?
As more of a product is consumed, total utility increases at a diminishing rate, reaches a maximum, and then declines. (b) Marginal utility, by definition, reflects the changes in total utility. Thus marginal utility diminishes with increased consumption, becomes zero when total utility is at a maximum, and is negative when total utility declines. Marginal utility is the change in total utility associated with each additional good consumed. Or, alternatively, each new level of total utility is found by adding marginal utility to the preceding level of total utility.
The law of diminishing marginal utility explains why the demand curve for a given product slopes downward.
If successive units of a good yield smaller and smaller amounts of marginal, or extra, utility, then the consumer will buy additional units of a product
only if its price falls.
Utility Maximization Rule
MU
x
Price
x
=
MU
y
Price
y
To maximize satisfaction, the consumer should allocate his or her money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility.
Utility Maximization Rule
Eg. You have $12.00 to spend.
Pizza has a marginal utility of 36 utils & price of $12.00.
Movie has a marginal utility of 24 utils and price of $6.00. Given proportion of utils to price, even though the total utils is higher for pizza, you would choose the movie rather than the pizza!
You could see 2 movies for the price of a pizza and exceed TU of pizza: 36 or 24+24
1st 2 dollars spent
leaves $8.00
same MU/$ for both, so buy both
leaves $5.00
choose orange - MU/$ > apple
leaves $3.00
indifferent to units @ 8 utils = buy both = $3.00
Consumers will continue to purchase the next good (X or Y) if it yields a higher utility return per price until both goods yield equal utility returns.
Substitution Effect on Marginal Utility
If the price of alternative good drops, the consumer will adjust spending to balance utilities.
Assume goods A (8/1) and B (16/2) yield 8 utils per dollar.
Price for B drops by half (16/1) - the last dollar spent on B now yields more utility (16 utils) than does the last dollar spent on A (8 utils). A switching of purchases from A to B is needed to restore equilibrium; that is, a substitution of now cheaper B for A will occur when the price of B drops.
Income Effect on Marginal Utility
The decline in the price of B from $2 to $1 increases
consumer’s real income. But at the lower $1 price for B, she now has more money to spend on goods that will yield more total utility. This rise in real income enables her to obtain more of A and B with the same income / budget. The income effect is the extra amount of B she decides to purchase because the decline in the price of B raised her real income.
But because he or she obtains less marginal utility from additional quantity of Good X , the consumer will choose not to buy more at that price. The consumer would rather spend additional dollars on products that provide more (or equal) utility, for Good Y & not less utility.
The basic determinants of an individual’s demand for a specific product are
(1) preferences or tastes,
(2) money income, and
(3) the prices of other goods.
HERE IS $500—GO SPEND IT AT AMAZON
Assume that you have received a $500 credit voucher (good for today only) from Amazon. Go to www. amazon.com/ and select $500 worth of merchandise. Use Add to Cart to keep a running total, and use Review Cart to print your final selection.
Compare your list with your classmates’ lists. What explains the differences?
Would you have purchased your items if you had received $500 in cash to be spent whenever and wherever you pleased?
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