Law of Demand people do less of what they want to do as the cost of doing rises at lower prices people do more and higher prices people will do less needs require for subsistence for survival beyond subsistence behavior is driven by wants 2 23 15 kidney or hamburger oatmeal or toaster pastries wants depend on price EX College a want Unlimited wants more things better quality things Services including entertainment travel limited resources money income wealth time and energy Utility the satisfaction people derive from consumption Cost benefit if the cost of doing activity is greater than benefit you stop doing it well being happiness The more she ate the less marginal utility she had Most satisfied when she ate her first cone The more consumed the less marginal utility Q 0 1 2 3 4 5 6 TU 0 50 90 120 140 150 140 MU 50 40 30 20 10 10 Law of Diminishing Marginal Utility tendency for additional utility gained from consuming an additional unit of good to decrease as consumption increases beyond some point Marginal utility can increase at low levels of consumption Eventually marginal utility declines continue consuming Apply cost benefit principle cost consume an additional unit as long as marginal utility benefit is greater than marginal Rational Spending Rule spending should be allocated across goods so that the marginal utility per dollar is the same for each good 2 25 15 utility the satisfaction people derive from consumption Ex well being happiness measured indirectly Subjective observable Cannot be compared between people Individual goal is to maximize utility satisfaction allocated resources accordingly EX Manny has a weekly allowance of 24 Pizza is 6 and Movie Rental is 3 0 20 36 48 58 66 72 76 78 MU 20 16 12 10 8 6 4 2 Pizza TU week 0 1 2 3 4 5 6 7 8 It will benefit manny the most to buy 3 pizzas 18 and 2 movie rentals 6 24 Total utility 48 46 94 Marginal utility per dollar is the same for each good the rational spending rule Movie Rental TU week 0 1 2 3 4 5 6 7 8 MU P 3 33 2 66 2 1 66 1 33 1 2 3 1 3 MU P 13 3 2 1 33 1 33 2 3 1 3 0 0 MU 40 6 4 4 2 1 0 0 0 40 46 50 54 56 57 57 57 EX Martha s marginal utility from consuming OJ is 75 utils per ounce and 50 utils per ounce of coffee If OJ is 25 cents per ounce and coffee costs 20 cents per ounce is she maximizing her total utility If so prove it if not how can she maximize it cost benefit principle MC MB 1st must figure out price per dollar for each good MU P OJ 75 25 300 utils per dollar Coffee 50 20 250 utils per dollar Therefore martha is not maximizing her total utility because her utils are not equal 2nd must figure out how she can maximize her total utility Because the marginal utility of OJ is higher 75 than coffee 50 you know you have to raise how much money you spend on OJ because that will give you the highest satisfaction Consumer Surplus difference between the buyer s reservation price and the market price Buyer reservation price the highest price the buyer is willing and able to pay EX The buyer s reservation price for a loaf of bread is 3 50 The market price is 50 cents at 50 cents the bakery is able to sell 100 loaves of bread Therefore the buyer has 3 00 left over To find consumer surplus you do 1 2 B H 1 2 100 3 150 EX The maximum I am willing to pay for a cup of coffee is 5 00 Currently I can buy a cup of coffee for 1 00 and the coffee shop sells 100 cups at this price Therefore I have 4 00 left over My consumer surplus is 1 2 100 4 200 dollars
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