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AP ECONOMICS CHAPTER 5
4 Key Concepts
Understanding Utility: Total and Marginal 2. Utility Maximization: Equalizing Marginal Utility per Dollar (MU/PA = MU/PB) 3. Individual and Market Demand Curves 4. Income and Substitution Effects (review from unit two)
1.
Introduction
The CONSUMER is essential to the market.
1. Understanding Utility
Utility = Satisfaction/Happiness/Pleasure one
gets from consuming a good. Utility and usefulness are NOT synonymous in economics. Utility is difficult to quantify, as it differs between people and situations
1. Understanding Utility
Total Utility (TU) Total amount of satisfaction or pleasure a person derives from consuming a given quantity of that product Marginal Utility (MU) The extra satisfaction a consumer derives from one additional unit of that product. In other words, the change in Total Utility that results from the consumption of one more unit
less utility he gets from each additional unit. Consumer wants in general are insatiable, but wants for particular items can be satisfied for a time.
begins to fall after the very first unit you consume. In other words, your very first taco holds great utility. While you may enjoy your second taco, it doesnt bring as much utility as the first At some point, your MU becomes negative. (takes away from your total satisfaction).
0 1 2 3 4 5 6 7
0 10 18
] ] ] 24 ] 28 ] 30 ] 30 ] 28
10 8 6 4 2 0 -2
Marginal Utility 10 8 6 4 2 0 -2 1 2 3 4 5 6 7
Units Consumed Per Meal
MU
2. Utility Maximization
Explains how consumers allocate their money
incomes among the many goods and services available for purchase You will be faced with problems that provide you with a consumers MU or TU derived from purchasing 2 goods. You will be expected to show how many of each a rational consumer would purchase.
10 8 7 6 5 4 3
10 8 7 6 5 4 3
24 20 18 16 12 6 4
12 10 9 8 6 3 2
First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Compare Marginal Utilities 16 Fourth 6 6 8 Then Compare Per 5 Dollar - MU/Price 6 Fifth 5 12 Choose the4Highest Sixth 4 6 3 Check Budget - Proceed to Next Item2 Seventh 3 3 4
First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Again, Compare Per Dollar -16 MU/Price Fourth 6 6 8 Choose the5Highest Fifth 5 12 6 Buy One of 4 Each Budget Has $5 Left Sixth 4 6 3 Proceed to 3 Next Item Seventh 3 4 2
First 10 10 Second 8 8 Third 7 7 Fourth 6 6 Again, Compare Per Dollar Fifth 5 5 Buy One More B 4 Budget Sixth 4 Proceed to 3 Next Item Seventh 3
First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Again, Compare Per Dollar - MU/Price Sixth 4 4 6 3 Buy One of 3 Each 3Budget Exhausted Seventh 4 2
First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 12 Final Result At 5 These Prices, 6 Sixth 4 4 6 3 Purchase 3 of Item A and 44 of B 2 2 Seventh 3
=
=
4
5
3
1
4
5
5
-5
4
5
46
48
4
5
22
20
utils from the 2nd candy bar, 0 utils from the 3rd candy bar, and -5 utils from the 4th candy bar
How many candy bars should Henry consume if each candy bar
Is absolutely free (MC = 0) Costs $2 Costs $4
Benefit is the same concept as utility, but it is measured in dollars (according to the consumers WILLINGNESS TO PAY. Total Benefit ($), Marginal Benefit ($)
until
MB = MC
To consume one more would mean your marginal cost is greater than your marginal benefit
limited resources
price to get market demand Add horizontally to create market demand curve
05_06
10
covered in unit 2. To review, just remember that both of these effects help to explain why the demand curve slopes downward.
A. B. C. D. E.
I only III only I and II only II and III only I, II, and III
Brian consumes? A. 3 units of utility B. 9 units of utility C. 12 units of utility D. 2 units of utility E. 14 units of utility
If the price of peanuts is $1 per cup and the price of jelly beans is $2 per cup, and Brian wants to maximize his utility, what should he purchase first? A. 1 cup of peanuts because peanuts produce a lower total utility B. 1 cup of peanuts because the price of peanuts is lower C. 1 cup of peanuts, because the marginal utility per dollar for peanuts is lower than the marginal utility per dollar of jelly beans D. 1 cup of jelly beans, because the marginal utility per dollar for jelly beans is higher than the marginal utility per dollar of peanuts E. 1 cup of jelly beans, because jelly beans produce a higher total utility
increased at a constant rate, no matter how many bratwurst Matt consumed, what would Matts demand curve for slices of cheese look like? A. Vertical B. Horizontal C. Downward sloping D. Upward sloping E. First upward, but eventually downward sloping
each, and oranges, at $2 each. At her current level of consumption, mollys marginal utility of apples is 12 and her marginal utility of oranges is 18. If she has already spent all of her lunch money, how should Molly change her consumption decision to maximize utility? A. She should make no changes; she is consuming the utility maximizing combination of apples and oranges. B. She should increase her apple consumption and decrease her orange consumption until the marginal utility per dollar is equal for both. C. She should decrease her apple consumption and increase her orange consumption until the marginal utility per dollar is equal for both. D. She should increase her apple consumption and decrease her orange consumption until the marginal utility is equal for both. E. She should decrease her apple consumption and increase her orange consumption until the marginal utility is equal for both.
consumer income causes A. the price of generic peanut butter to go down. B. the demand for name-brand peanut butter to go up. C. the supply of generic peanut butter to go up. D. the demand for generic peanut butter to go up. E. the price of bread to go down.
Key Terms
law of diminishing marginal utility utility total utility marginal utility rational behavior budget constraint utility-maximizing rule
income effect
substitution effect
$2 1
4 6
Price of Product B
Income Effects
0
DB
4 6
Substitution Effects
Quantity Demanded of B