Economics 211 Chapter 6 Study Guide

Budget Line

All combinations of two goods that can be purchased with a given income and fixed prices of each good

Utility

A hypothetical measure of the satisfaction one receives from consuming a good or service

Total Utility

The total satisfaction from consuming given quantity of a good or service

Marginal Utility

The additional satisfaction from consuming one more unit of a good or service

Marginal Utility Analysis

Studies consumer decision making in the face of budget constraints

Asserts that rational consumers will allocate their incomes to maximize their own well-being

Determines at which point on the budget line one consumes to maximize utility

Diminishing Marginal Utility

As one consumes more of a given product, the additional satisfaction from each additional unit decreases

Utility-Maximizing

Individuals maximize total satisfaction by consuming where marginal utility per dollar is equal for all goods and services

How will consumers react if the price of a good falls?

A price change alters the optimal combination of goods purchased

It is also reflected as a movement along the demand curve

Limits of Marginal Utility Analysis

-Do consumers really measure the utility they receive from consuming various goods?

-Do consumers really calculate the marginal utility associated with each activity?

Behavioral Economics

The study of how human psychology helps explain why individuals sometimes act in predictable ways counter to economic models

Sunk cost fallacy

Decisions are influenced by costs already incurred, instead of how the decision affects current well-being

Example: Refusing to leave a bad movie because you already paid

Framing Bias

Techniques used to steer individuals to making one decision over another

Example: Buy one, get one 50% off versus 25% off the entire purchase

Overconfidence

You are overconfident

Example: Many gym memberships go unused because ambition exceeds follow-through

Overvaluing the present relative to the future

You don’t think about the future

Example: Not participating in company-sponsored retirement programs

Altruism/Charity

Charity

Example: Why do people leave generous tips if it does not affect the quality of service already provided?