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Unit One: Basics

Unit One: Basics. Topic: Consumer Behavior. Learning Targets. I will be able to describe how a consumer should adjust consumption in order to maximize satisfaction. Assumptions. Rational behavior – consumers want the maximum satisfaction from their purchases. All consumers have preferences.

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Unit One: Basics

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  1. Unit One: Basics Topic: Consumer Behavior

  2. Learning Targets • I will be able to describe how a consumer should adjust consumption in order to maximize satisfaction.

  3. Assumptions • Rational behavior – consumers want the maximum satisfaction from their purchases. • All consumers have preferences. • All consumers have a budget constraint. • Price is affected by scarcity (individual purchases do not affect price).

  4. Total Utility (TU) • Def: total amount of satisfaction derived from the quantity of consumption of a good or service. • TU increases at a diminishing rate, reaches a max., and then declines. TU (utils) TU Quantity consumed

  5. Def: additional satisfaction obtained from consuming one more unit of a good/service. Reflects changes in TU; diminishes with increased consumption, is zero when TU is at a max., and is negative when TU declines. Marginal Utility (MU) TU TU Q MU Q MU

  6. (The Law of) Diminishing Marginal Utility • Diminishing = decreasing • Marginal = change in, extra, additional • Utility = usefulness, satisfaction • Therefore, DMU = at some point, the consumption of a good/service reaches a maximum point of satisfaction/usefulness and then begins to decrease.

  7. Example: Eating Donuts • You are hungry (very hungry). What is your current satisfaction on a scale of 0-10, with zero being an empty stomach? • Zero! • You eat a donut. What happens to your satisfaction/utility from eating that donut (how full are you)? • Two. What is your marginal gain from eating that 1st donut?

  8. Utility-Maximizing Rule • The consumer should allocate his/her money so that the last dollar spent on each product yields the same amount of MU. • Formula (for products a, b, and c): MUa/Pa = MUb/Pb = MUc/Pc…

  9. Practice For each of the following indicate if the consumer is maximizing utility. If (s)he is not, explain how they should adjust their purchasing to maximize utility. 1. MUa = 6, Pa = 3, MUb = 6, Pb = 2 2. MUx = 20, Px = 4, MUy = 4, Py = 1 3. MUa = 6, Pa = 3, MUb = 20, Pb = 4

  10. Demand is the amount of a good or service consumers are willing and able to purchase at certain prices. Consumers base their willingness to buy an item on the utility of that item, therefore, quantity depends on utility (price). The demand curve slopes downward because as price increases, quantity demanded decreases. A little bit about demand… Good Z Price D Quantity

  11. Consumer Surplus • Def: the usefulness or worth of a good/service to a consumer is more than the price. • Example: Jason is willing to purchase a pair of diamond earrings for $400 (gotta keep his woman happy). The price of the earrings is only $300 at the jewelry store. His consumer surplus is the value of the $100 difference.

  12. Every consumer who is willing to pay more than $300 for the same pair of earrings benefits from buying them at $300 (like Jason). Consumer surplus reflects the sum of all “benefits.” Consumer Surplus Diamond Earrings Price Consumer surplus $300 D Quantity

  13. Purchasing Power • Def: the amount of “stuff” you can buy with your money (also called real income). • If prices increase, your purchasing power will decrease. • If prices decrease, your purchasing power will increase.

  14. Substitution Effect • Def: the impact that a change in a product’s price has on its relative expensiveness (and, therefore, on its quantity demanded). • In plain English…basically, you buy the cheapest of similar products. If the price of one product changes, it will change the QD for all similar products.

  15. Income Effect • Def: a change in the price of a product changes the consumer’s purchasing power. • Ex: The price of Wendy’s chicken nuggets increases from $1 to $2. How does that change your purchasing power?

  16. How these affect QD… • Combined, the law of DMU, the substitution and income effects change consumers’ willingness and ability to purchase goods and services. • These help explain the slope of the demand curve.

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