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Consumer Behavior & Utility Maximization . Chapter 8. Income & Substitution Effects. Income Effect - Impact of a product price change on a consumer’s real income and on quantity demanded.
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Consumer Behavior & Utility Maximization Chapter 8
Income & Substitution Effects • Income Effect- Impact of a product price change on a consumer’s real income and on quantity demanded. • Substitution Effect- Impact of a product price change and your willingness to buy that product as opposed to a substitute item.
Utility • Satisfaction or pleasure one gets from consuming a product. • Utility for a product varies from person to person • Difficult to measure
Total Utility & Marginal Utility • Total Utility- Total amount of satisfaction a person derives from consuming some specific quantity (I.e. 10 units) • Marginal Utility- The extra satisfaction a consumer realizes from an additional unit of that product. (I.e. going from the 10th unit to the 11th the difference between the two).
Law of Diminishing Marginal Utility • Consumers fulfill specific wants with succeeding units of a commodity • Each added unit provides less utility (satisfaction) than the last unit purchased.
Theory of Consumer Behavior • The typical consumers situation has the following dimensions: • Rational behavior • Get most out of their $ • Preferences • Clear-cut preferences for goods/services • Budget constraint • Fixed amount to spend • Prices • Every good carries a price tag
Utility-Maximizing Rule • To maximize satisfaction, the consumer should allocate his or her income so that the last dollar spent on each product yields the same amount of marginal utility. • Marginal Utility per Dollar- Before applying the utility maximizing rule to these data, we must put the MU information on a per-dollar-spent basis
Budget Line • Schedule or curve that shows various combinations of two products a consumer can buy with a specific money income. • Characteristics • Income changes • Increase in money income shifts the budget line to the right; decrease to the left. • Price changes • Decline in prices of both products shifts the curve to the right. Increase in prices of both shifts the curve to the left.
Indifference Curves • Shows all combinations of two products that will yield the same utility to the consumer
Indifference Map • Series of indifference curves • Each curve reflects a different level of total utility
Consumers Equilibrium Position • Budget Line – Combinations of products a customer can afford • Of these combinations, the consumer would prefer the combination that provides the greatest utility • The equilibrium position is the point that is on the budget line but on the furthest indifference curve