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Utility- is the satisfaction you receive from consuming a good or service
Total utility is the number of units of utility that a consumer gains from
consuming a given quantity of a good, service, or activity during a
particular period
Utility cannot be measured by an actual scale or standard
If utility could be measured, it would not be measuring a characteristic of
goods but a particular consumer’s reaction to those goods
Total utility generally rises at a decreasing rate.
Marginal utility is the amount by which total utility rises with
consumption of an additional unit of a good, service, or activity, other
things unchanged
The Law of Diminishing Marginal Utility is the tendency of marginal
utility to decline beyond some level of consumption during a period
Maximizing Utility
1. The budget constraint
a. Total spending cannot exceed the budget available
b. The budget constraint is the maximum money available for
spending
c. A simplifying assumption is that only current income can be used
for spending; the consumer neither borrows nor saves
2. Applying the marginal decision rule
a. The marginal benefit to a consumer of spending another dollar on a
good is the marginal utility of that expenditure MB = MU/P
b. The marginal cost to a consumer of spending one dollar less on a
good is the loss of additional utility that could have been gained from
spending that dollar on the good
MC = MU/P
MB = MC
c. Equilibrium between two goods is reached when the marginal utility
per dollar spent is the same for the two goods (the marginal benefit of
shifting one dollar into one good is exactly offset by the marginal cost
of shifting out of the other good
d. The utility maximizing condition states that utility for a given budget
when total outlays equal the budget and when the ratios of marginal
utilities to price are equal for all goods and services
3. The problem of divisibility
a. For the utility-maximizing condition to be met perfectly, all the goods
must be completely divisible so that they can be divided meaningfully
into dollar amounts
b. This divisibility requirement is almost never met in actuality
c. The model does predict that consumers will get as close as possible
to the utility maximizing condition
Utility Maximization and Demand
A. Deriving and Individual’s Demand Curve
1. A price decline in one product makes that good’s ratio of marginal
utility to price higher than before and encourages more spending on it
2. The utility-maximizing condition therefore results in a negatively
sloped individual demand curve.
B. From individual to Market Demand
1. A price decline affects all individuals in the market in the same
direction even though each individual has potentially unique
preferences.
2. The market demand curve is made up of all the individual demand
curves
C. Substitution and Income Effects
1. A price decline for a product makes that product relatively less
expensive
2. A price decline for a product effectively makes consumers of that
product richer
3. An income-compensated price change is an imaginary exercise in
which we assume that when the price of a good or service changes,
the consumer’s income is adjusted so that he or she has just enough
to purchase the original combination of goods and services at the
new set of prices.
4. The substitution effect of a price change is the change in a consumer’s
consumption of a good in response to an income-compensated price
change
5. The income effect of a price change is the change in consumption of
a good resulting from the implicit change in income because of a
price change
D. Normal and Inferior Goods
1. Normal goods
a. The substitution and income effects reinforce each other in the case
of normal goods
b. The substitution effect contributes to an increase in the quantity
demanded because consumers substitute more of the other goods
when the price of the normal good decrease.
c. The income effect of a price decline of a normal good is to increase
purchasing power and therefore increase the quantity of the good
demanded
d. An increase in the price of a normal good results in a decline in
quantity demanded through both the substitution and income effects
2. Inferior goods
a. When the price of an inferior good falls, consumers will substitute
more of the inferior good for other goods because of the substitution
effect
b. When the price of an inferior good falls, the lower price effectively
makes consumers richer, so they purchase less of the good through
the income effect
c. The substitution and income effect work in opposite directions for
inferior goods