Transcript AP Economics

AP Economics
Chapter 21 : Consumer Behavior
and Utility Maximization
I. Two Explanations of Law of
Demand
A. Intro > Why do consumers buy particular goods? >
Links consumer behavior with Law of Demand.
B. Income Effect > Increase in price means less real
income is available to buy product, hence Quantity
Demanded decreases. (inverse relationship)
C. Substitution Effect > Increase in price of one
product means it is relatively more expensive than
another product. Thus, the consumer will buy less and
Q.D. decreases. (inverse relationship)
* Points B & C above are the first explanation of L of D
D. Law of Diminishing Marginal Utility >
The more of a product consumers attain,
the less they will desire of it.
1) Marginal Utility & Total Utility
2) Successive units attained/consumed
yield smaller Marginal Utility (MU).
Thus, prices must fall to attract more
consumer purchase.
3) Inelastic D > If MU falls sharply, D is
inelastic and price must fall
dramatically to attract consumers.
4) Elastic D > If MU falls modestly, D is
elastic and price doesn’t have to fall
much to attract consumers.
II. Theory of Consumer
Behavior
A. Consumer Choices & Constraints
1) Are rational & choose
2) Have clear tastes & choose
3) Have limited means & choose
4) Must choose from options
B. Utility Maximization Rule (UMR) > explains how
consumers spend their $ so that the last dollar spent
on each product yields the same MU. The
consumer is in equilibrium in amount spent and
quantity purchased of each product at this level.
1) No need to change the setup, unless taste,
income, or price changes.
2) If good, provides more utility over another
good, consumers will purchase that good over the
other. MU will eventually decrease and both will be
equal MU.
3) See T.21-2, p.430 for hypo ex.
4)Formula> Utility Maximization is where MU of
prod. A/price of prod. A = MU of prod. B/price of
prod.B.
III. Utility Max. & The D Curve
A. UMR helps to explain the extent of the…
1. Substitution Effect > when price ,
equilibrium will only be reached when more
of this item is bought. How much more?
Depends on how MU interacts with price and
the alternative product.
2. Income Effect > how much more is purchased
depends on interaction of MU, price, and your
income level.