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Consumption Theory

Consumption Theory. Why Growth and maintenance of life process Comfort Satisfaction – utility Pleasure – utility Display-Advertise status or perception of status Emulation. Utility Theory and Individual Choice. According to economists, our behavior is motivated by rational self interest.

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Consumption Theory

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  1. Consumption Theory • Why • Growth and maintenance of life process • Comfort • Satisfaction – utility • Pleasure – utility • Display-Advertise status or perception of status • Emulation

  2. Utility Theory and Individual Choice • According to economists, our behavior is motivated by rational self interest. • According to this theory, two things determine what people do: • The pleasure people get from doing or consuming something • The price of doing or consuming that something.

  3. Utility and Consumption • Total Utility • Marginal Utility • Next unit • Change in total utility from next unit of consumption • Diminishing Marginal Utility • Time • More is less

  4. Diminishing Marginal Utility • . The principle of diminishing marginal utility – after some point, the marginal utility received from each additional unit of a good decreases with each additional unit consumed. • As additional units are consumed, marginal utility decreases, but total utility continues to increase. • When total utility is at a maximum, marginal utility is zero. • Beyond this point, total utility decreases and marginal utility is negative

  5. 14 1 2 3 4 5 6 7 8 9 Marginal and Total Utility Number of pizza slices Total utility Marginal utility 14 26 12 36 10 44 8 50 6 54 4 56 2 56 0 54 -2

  6. 70 60 Marginal and Total Utility 50 Total utility 40 30 20 10 Total utility 0 Q Marginal utility 1 2 3 4 5 6 7 8 9 16 14 12 10 8 Marginal utility 6 4 2 0 Q 1 2 3 4 5 6 7 8 9 -2

  7. Maximizing Utility How to get the most for your Money Maximizing Utility – relationship of utility to price MU/P • MUa/Pa = MUb/Pb • And so on for all goods • Consume another unit of a if: • Consume another unit of b if:

  8. A Numerical Example • MUa/Pa = MUb/Pb • MUa = 20 • Pa = 10 • MUb = 50 • Pb = 50 MUa/Pa = 20/10 2 MUb/Pb = 50/50 1 2 > 1 So buy more of good a

  9. A Numerical Example -- continued But consuming more of a It’s marginal utility decreases • MUa/Pa = MUb/Pb • MUa = 10 • Pa = 10 • MUb = 50 • Pb = 50 MUa/Pa = 10/10 1 MUb/Pb = 50/50 1 1 = 1 So = nirvana

  10. P Consumer Surplus Consumer Surplus S Pe D Qe Q Consumer Surplus

  11. But then Reality Sets In • Getting MUa/Pa = MUb/Pb may be difficult to do • How do we know what MU is for each good we buy Example – Alcohol • Beer • Wine • Liquor

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