Chapter 21: Consumer Behavior and Utility Maximization

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Chapter 21 Consumer Behavior and Utility
Maximization

• Content and Visuals from McConnell/Brues
  Economics

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As always, I think about me

• As a consumer, we all always act in our own
  self-interest when we buy
• We buy more when the price is low, less when the
  price is high
• Lets revisit the reasons why
• Although accidental, I just might cry

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Income Effect

• If you have a fixed quantity of money and prices
  go up, by default you simply cannot buy as much
• If I get paid 10 a week and buy only Frooties
  for .01 each I can buy 1,000 of them
• If they raise the price to .02 I can only buy
  500, demonstrating the law of demand
• The same also applies if your income changes but
  prices remain constant

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Substitution Effect

• I like to drink sodaif Pepsi is cheaper I buy
  itif Coke then I buy Coke
• As prices rise we buy less as we tend to
  substitute a cheaper product instead

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Diminish Marginal Utility

• I love big TVs, and the MU of having one at home
  is probably around 500
• The MU of the second though is only probably 50
• Once you have one, of most things, the added
  value of you having another one is highly
  diminished
• That being said you will be less likely to buy
  another one unless the price is lower

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Total versus Marginal

• Important to distinguish between total utility
  and marginal utility
• Marginal utility is the amount of each extra bite
  you take
• Total utility is the entire value of what you ate
• The first bite of pizza might be worth .75, then
  .70 and so on, producing a total value of 10
  for the entire pie

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CONSUMER EQUILIBRIUM

• Critically important concept for us
• As a consumer you do what is best for you, so
  when you make purchases you should do so to
  maximize your utility
• In the long run then your TOTAL UTILITY will be
  maximized when the MU/cost of each item is equal
  (as as high as possible)
• (MU1/P1) (MU2/P2)

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Paradox of Value

• Since the MU is what dictates what we purchase,
  not the total utility, a paradox arises
• Which do we get more value fromwater or
  diamonds?
• In terms of total utility we gain more from water
  since you die without it
• In terms of marginal utility we gain more from
  the diamonds
• Price will be determined by MU even though the
  total utility of something else might be much
  greaterbut would you pay 1,000 for a glass of
  water?

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Elasticity Tutorial Practice

• http//hspm.sph.sc.edu/COURSES/ECON/Elas2/Elas2.ht
  ml

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Summary

• As we enter microeconomics, things will make more
  sense if you can always connect it to the idea
  that you do what is good for you
• It doesnt matter if you are an individual, a
  business, or the government, SELF-INTEREST
  provides the rationale and eliminates the need to
  think about things