Chapter 6 Notes 6.1 Law of Diminishing Marginal Utility ...
ECN 104 – Chapter 6 Notes 6.1 Law of Diminishing Marginal Utility gains in satisfaction decline as additional units are consumed terminology utility: want-satisfying power total utility: total amount of satisfaction marginal utility: extra satisfaction from consuming one more unit disutility: opposite of utility (not satisfied) Marginal Utility & Demand diminishing marginal utility provides a sample rational of the law of demand successive units of a good yield smaller amounts of marginal utility consumer buy additional units only if prices fall marginal utility decreases rapidly for each successive unit it will take a considerable decrease in price to cause increase in demand demand is elastic 6.2 The Theory of Consumer Choice Typical Consumer exhibits rational behaviours – get most for least amount of $ (max satisfaction) has clear cut preference – knows how much satisfaction is acquired from additional unit subject to budget constraint respond to price changes – each tries to max satisfaction Utility-Maximizing Rule
Utility Maximization spend where MU/$ is highest if MU/$ = unequal, spending should be allocated award from good where MU/$ = low toward good when MU/$ = high Utility Maximization and the Demand Curve Substitution Effect when price of oranges fall, there will be a substitution of now cheaper oranges Income Effect increase in real income = increase consumption of both apples and oranges 6.4 Applications and Extensions New products iPod Diamond-water paradox – water increase U, but lowers, MU b/c diamonds are scarce Opportunity cost & time – time consumed must be included in price of product/service Cash & noncash gifts – which do you prefer? Most likely cash, why?
Losses and Shrinking Packages To consumers, price increases = loss relative to status quo Producers reduce package size instead of raising prices Framing Effects and Advertising Consumers evaluate events in a particular mental frame New info alters the frame that consumer defines whether situations are gains or losses Anchoring and Credit Card Bills Estimates of value are influenced by recent info no matter how irrelevant Can lead to people altering valuations unconsciously Mental Accounting and Overpriced Warranties separate purchases into “mental accounts” instead of looking at big picture mental accounting exaggerates any potential loss Endowment Effect and Market Transactions market transactions may be affected by endowment effect b/c: seller has tendency to demand a higher price buyer has tendency to offer a lower price
Utility Maximization spend where MU/$ is highest if MU/$ = unequal, spending should be allocated award from good where MU/$ = low toward good when MU/$ = high Utility Maximization and the Demand Curve Substitution Effect when price of oranges fall, there will be a substitution of now cheaper oranges Income Effect increase in real income = increase consumption of both apples and oranges 6.4 Applications and Extensions New products iPod Diamond-water paradox – water increase U, but lowers, MU b/c diamonds are scarce Opportunity cost & time – time consumed must be included in price of product/service Cash & noncash gifts – which do you prefer? Most likely cash, why?
Losses and Shrinking Packages To consumers, price increases = loss relative to status quo Producers reduce package size instead of raising prices Framing Effects and Advertising Consumers evaluate events in a particular mental frame New info alters the frame that consumer defines whether situations are gains or losses Anchoring and Credit Card Bills Estimates of value are influenced by recent info no matter how irrelevant Can lead to people altering valuations unconsciously Mental Accounting and Overpriced Warranties separate purchases into “mental accounts” instead of looking at big picture mental accounting exaggerates any potential loss Endowment Effect and Market Transactions market transactions may be affected by endowment effect b/c: seller has tendency to demand a higher price buyer has tendency to offer a lower price
