Utility
A measure of satisfaction you get form consuming a product
- utility & usefulness are not synonymous
- Utility is subjective
- Difficult to quantify
Law of Diminishing Marginal Utility
Added satisfaction declines as a consumer acquires additional units of a product
Marginal Utility
Satisfaction gained from each additional unit
Total Utility
Total amount of satisfaction gained from consuming multiple units
Sum of all marginal utility
Ordinal
Values defined by ranking of preference
Used to make interpersonal comparisons of utilities
Cardinal
Units of specific measurements like inches or feet, specific numbers
Consumer Choice
- Rational behavior: want greatest utility
- Preferences: each has their own utility ranking
- Budget constraint: fixed income
- Prices: everything has a price and you have limited income
Utility Maximizing Rule
Spend money so that each dollar spent maximizes their utility for each purpose
Consumer Equilibrium
When a consumer has maximized his utility
Once achieved the consumer will not alter his spending
Marginal Utility per Dollar
MU / Cost
Decision Rule for Utility Maximization
Purpose items that give the greatest marginal utility per dollar
Income Effect
Impact that a price change has on a consumers real income and the demand for a good.
Substitution Effect
Impact that a price change has on its quantity demanded
Value of Time
Consumption and production of time. With time taken in account less expensive could be more expensive
Behavioral Economics
How people deal with negative possibilities
Prospect Theory
How consumers plan for and deal with ups and downs
- People judge good and bad based on status quo
- Experience diminishing marginal utility for gains and losses
- Loss adverse: losses are felt 2.5 times more intense
Framing Effects
Change in preferences caused by new information that alters the perception of gains and losses
Anchoring
Setting a tone in order to lead people unconsciously to later their evaluation
Mental Accounting
Put certain options into separate mental accounts and don’t consider them when making a decision
Endowment Effect
People put higher valuation on things they posses
Ordinal Utility Ranking
AKA - Indifference curve analysis
- Budget lines
- Indifference curve
Budget Line
AKA - Budget Constraint
Curve showing all combinations of two products that can be purchases with certain amount of money.
Value of slope is Px/Py
- Income change: increase in income shifts right
- price change: decrease in price shifts right
Indifference Curves
Combination of two products that will yield total satisfaction - independent of price
- Normal goods: downsloping curve (hats and snickers)
- Perfect substitutes: linear downsloping (red and blue m&m’s)
- Perfect compliments: right angle (left and right shoes)
MRS
Marginal Rate of Substitution
Measurement of the slope of an indifference curve and the rate at which you will give up one good for another
Must substitute one good for another for maximum utility
As one increases the other decreases (concurve downslope)
