Topic 4 Microeconmics

Law of Diminishing Marginal Utility

Wants for specific commodities can be fulfilled. The more of a specific product that consumers obtain, the less they will desire more units of that product.

Utility

A subjective notion in economics referring to the amount of satisfaction a person gets from consumption of a certain item.

Marginal Utility

The extra utility a consumer gets from one additional unit of a specific product; declines with each successive unit (diminishing marginal utility).

Theory of Consumer Behavior

Explains how consumers allocate income based on the law of diminishing marginal utility.

Consumer Choice & Budget Constraint

Consumers are rational, have preferences, face limited incomes, and must choose among goods.

Utility Maximizing Rule

Consumers allocate income so that the last dollar spent on each product yields the same amount of extra utility.

Consumer Equilibrium

Occurs when utility is balanced per dollar at the margin, with no incentive to alter spending unless tastes, income, or prices change.

Marginal Utility Per Dollar

Consumers compare the extra utility from each product with its cost.

Algebraic Utility Maximizing

Consumers allocate income so MU of product A/Price of A = MU of product B/Price of B = etc.

Consider This: Taste

Calorie counts on menus may not change behavior because some people maximize calories per dollar rather than healthfulness per dollar.

Utility Maximization & Demand Curve

Consumers buy more of a product as its price falls, which is shown by the utility maximizing rule.

Substitution & Income Effect

When a price declines, more of the item is purchased until marginal utility per dollar equals that of other products.

Income Effect

A decline in price expands real income, prompting consumers to purchase more until equilibrium is restored.

A New iPad Example

Shows how new products succeed by enhancing consumers' total utility.

Diamond-Water Paradox

Essential goods like water have lower prices than luxuries like diamonds due to abundance and marginal utility.

Time Value

Opportunity cost of time is included in the total price of an item, affecting consumer decisions.

Medical Care & Buffets

Consumers buy more medical care or food at a buffet when the cost is fixed or reduced.

Cash vs Noncash Gifts

Noncash gifts may provide less utility than cash due to preference mismatches.

Budget Constraint Line

Shows combinations of two products that can be purchased with a given income and prices.

Indifference Curves

Show all combinations of two products that yield the same level of satisfaction; downward-sloping and convex to the origin.

Indifference Map

Shows successive indifference curves, each representing a higher level of utility, where utility maximization occurs where the budget line is tangent.

Marginal Rate of Substitution

The slope of the indifference curve, equivalent to the ratio of marginal utilities of two goods.

Demand Curve

Derived from indifference curves by observing how quantity purchased changes with price changes.