Chapter 6 The Economics of Collective Decision Making The Size and Growth of the US Government a The 3 major categories of federal spending I i Healthcare ii Social security iii National defense b Transfer Payments transfers of income from some individual who pays the taxes to others who receive government payments i Example social security unemployment benefits and welfare II Similarities and Differences between Governments and Markets a Competition is present in both i Example politicians compete for office employees compete for promotions and higher pay rates b Scarcity and Opportunity cost present in both If resources are used to achieve one goal then they are not present to achieve another i ii Chapter 7 Consumer Choice and Elasticity I Fundamentals of Consumer Choice a Basics of Consumer Choice i Limited income necessitates choice 1 Scarcity limited income 2 When more of one good service is bought then ii Consumers make decisions purposefully 1 If 2 products are the same in price the consumer will buy the one with more benefit If 2 products yield the same benefit then the consumer will buy the cheaper one iii One good can be substituted for another 2 1 Utility satisfaction 2 Example either a hamburger or a taco can satisfy hungry a High water prices in California have made residents substitute flower gardens for cactus ones iv Consumers must make decisions with perfect information but knowledge and past experience help 1 Time and effort used to find information is directly related to the value derived from it 2 Consumers spend more time and money to inform themselves about big ticket items 3 Experience helps make decisions v The law of diminishing marginal utility applies as the rate of consumption increases the marginal utility gained from consuming additional units of a good will decline 1 Law of diminishing marginal utility the basic economic principle that as the consumption of a product increases the marginal utility derived from consuming more of it will decline 2 Marginal utility the additional utility derived from consuming as additional unit of a good 3 Example even though you might like ice cream the more you eat the more you hate it a In class example sweaters that your gave you for holidays 4 No matter how much you like a product you won t spend your entire budge on it II Marginal Utility Consumer Choice the Demand Curve of an Individual a The height of an individual s demand curve at any specific unit is equal to the maximum price the consumer would be willing to pay for it i Marginal benefit the max price b Because a consumer s willingness to pay for a unit of a good is directly related to the utility derived from consuming the unit the law of diminishing marginal utility implied that a consumer s marginal benefit and thus the height of the demand curve falls as the quantity consumed increases i Marginal utility will fall as quantity increases c At any given price consumers will purchase all units of a good for which their maximum willingness to pay marginal benefit is greater than the price i MB P ii When a consumer has purchased all units to the point at which MB P total consumer surplus is maxed d Consumer Equilibrium with many Goods i Consumer choice is a constant comparison of value to relative price 1 Example seeing a shirt that you like and then seeing that it was 50 You say Wow that s too much saying I like the shirt but not as much as the 50 worth of other goods that I would have to give up for it ii the consumer will maximize his her utility by ensuring that the last dollar spent on each good purchased yields an equal degree of marginal utility 1 Example you re at a restaurant eating wings and drinking Coke Assume a large coke and wings cost 2 When you finish your Coke there are a lot of wings left You ve eaten so many that the rest do not look attractive You could have gotten more utility with fewer wings and another coke but too late In this condition marginal utility of wings is lower than the marginal utility of a Coke If you purchased fewer wings and more Coke your utility would be higher 2 You maximize your utility and get the most bang for your buck from your budget when you make the two ratios the two marginal utilities equal to each other e Price Changes and Consumer Choice i The demand curve shows the amount of a product that consumers are willing to buy at alternative prices during a specific time period The law od demand states that the amount of a product bought is inversely related to its price ii As the price of a product declines the lower opportunity cost will induce consumers to buy more of it iii Substitution effect that part of an increase in amount consumed that is the result of a good being cheaper in relation to other goods because of a reduction in price If a consumer s money income is unchanged a reduction in the price of a product they consume will increase his or her real income iv v 1 Example if your rent declined by 100 per month that would allow you to buy more of many other goods Income effect the part of an increase in amount consumed that is the result of the consumer s real income being expanded by a reduction in the price of a good 1 Response buying more of the cheaper product and other product because they can better afford to do so f Time Costs and Consumer Choice time is money i ii A lower time cost will make a product more attractive 1 Example patients in a dentist office are willing to pay an extra 5 per minute saved to shorten their time spend in waiting rooms iii Time costs differ among individuals g Market demand Reflect the Demand of Individual Consumers i The market demand schedule is the relationship between the market price of a good and the amount demanded by all individuals in the market area Because individual consumers purchase less at higher prices the amount demanded in a market area as a total is also inversely related to its price the market demand curve represents the collective choices of the individual consumers ii III Elasticity of Demand a Price Elasticity of Demand indicated how responsive consumers are to a change in a product s price i Price elasticity of demand 1 Elasticity coefficient percentage change quantity demanded percentage change price ii A change in price causes the quantity demanded to change in the opposite direction the price elasticity coefficient is always negative iii Example Ford Explorer s price goes up 10 while others remain the same It is expected for Ford s sales
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