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Consumer Behavior, Utility Maximization, Indifference Curves

Consumer Behavior, Utility Maximization, Indifference Curves. Income Effect. Impact Δ price of product has on real income/purchasing power (real vs. nominal) and therefore on quantity demanded Inflation/deflation Objective measure: true regardless of changes in other goods.

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Consumer Behavior, Utility Maximization, Indifference Curves

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  1. Consumer Behavior, Utility Maximization, Indifference Curves

  2. Income Effect • Impact Δ price of product has on real income/purchasing power (real vs. nominal) and therefore on quantity demanded • Inflation/deflation • Objective measure: true regardless of changes in other goods

  3. Substitution Effect • Impact Δ price product on relative expensiveness and therefore QD • Subjective measure: inoperative if everything else gets more expensive too

  4. Law of Diminishing Marginal Utility • Utility: want-satisfying power • 1) not usefulness; 2) subjective; 3) but quantifiable: utils • Total utility vs. marginal utility • Helps explain demand curve (have to cut prices to sell more as MU diminishes) and elasticity (how quickly MU diminishes: fast= inelastic, slower = elastic)

  5. Theory of Consumer Behavior • 1) Rational: maximize total utility • 2) Preferences: good idea of marginal utility • 3) Budget restraint: finite resources + therefore income • 4) Prices: product prices not affected by amount individual buys (unlike Bootie Beer stocks)

  6. Utility-Maximizing Rule • “The consumer should allocate his/her money income so that the last dollar spent on each product yields the same amount of marginal utility” “balance the margins” equilibrium, ceteris paribus

  7. A: price =$1;B: price =$2; Income $10

  8. Algebra • MU A/$A = MUB/$B

  9. Indifference Curves • Budget line: a schedule or curve that shows various combinations of two products a consumer can purchase with a specific money income • Income Δ Δ curve (up right; down left) • Price Δ: if both Δ shift; if one slope Δ Unattainable Attainable (inefficient) Attainable (efficient)

  10. Indifference Curve • IC: Shows all combinations of two products A and B which will yield the same total satisfaction/utility to a consumer • Gets same utility from any combination, so indifferent to which combination • Downsloping: more of one means less of the other • Convex to origin: diminishing slope as move down marginal rate of substitution: willingness to substitute B for A diminishes as move down curve: as amount of B increase, MU of B decreases while as quantity A decreases MU of A increases (and vice versa)

  11. Indifference Map

  12. Perfect Substitutes

  13. Perfect Complements (l+r shoes)

  14. Equilibrium position: intersection budget line and highest indifference curve

  15. Difference Marginal Utility Theory and Indifference Curve Theory • MUT requires consumer knows MU • ICT requires only that knows that different combination generates more or less satisfaction but not how much more/less • Nevertheless, at equilibrium Pb/Pa= MUb/MUa so both give same result

  16. Deriving a Demand Curve from the Indifference Curve

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