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ECON Chapter 7

by: Lucy Notetaker

ECON Chapter 7 ECON 200

Lucy Notetaker

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All about utility
Principles of Economics: Microeconomics
Dr. Robert Schwab
Class Notes
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This 3 page Class Notes was uploaded by Lucy Notetaker on Monday October 17, 2016. The Class Notes belongs to ECON 200 at University of Maryland taught by Dr. Robert Schwab in Fall 2016. Since its upload, it has received 15 views. For similar materials see Principles of Economics: Microeconomics in Economics at University of Maryland.


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Date Created: 10/17/16
ECON 200: Chapter 7 All About Utility Utility- a measure of the amount of satisfaction a person derives from something - Example: I would more utility out of writing a novel than sitting and staring at a wall for 6 hours (weird example, but you get the idea) - You can get utility from all different goods and services - If something is free and you still wouldn’t consume it (A rotten apple) we say it decreases your utility - Utility maximization- we act in a way that will give us the most utility (it’s rational) Revealed Preference - Utility is obviously very subjective - We can measure utility by observing behavior (if someone orders food then you can assume they will get more utility out of that food than saving the money) - Revealed Preference- the idea that people’s preferences can be determined by observing their choices and behaviors - This gets interesting, cause say you’re roommate says “I want to stop drinking” but he goes out and gets drunk every night. Revealed preference would say that he actually wants to continue drinking (hello psychology) Utility Functions - We can’t always observe people - Utility Function- a formula for calculating the total utility that a person derives from consuming a combination of goods and services - Bundle- a unique combination of goods that a person could choose to consume - Everything is relative, but we can assign numbers to utility - If I give riding my bike a utility of 5 and taking the bus a utility of 3, all this is saying is riding my bike has a higher utility - I can multiple 5 by the number of hours I ride my bike then multiply 3 by the number of hours I ride the bus to calculate, add these two numbers together, that’s total utility - For sake of example, let’s say I ride each for two hours - Bike (2 x 5) + Bus (2 x 3)= 16 is my total utility Marginal Utility - Because nothing is good in excess, this exists - Marginal Utility- the change in total utility that comes from consuming one additional unit of a good or service - Diminishing Marginal Utility- a principle that the additional utility gained from consuming successive units of a good or service tends to be smaller than the utility gained from the previous unit. - Example: We’ve all had that smoothie where the first sip was good, but each sip just got worse and worse. - A negative marginal utility means consuming another would actually hurt your utility. Going back to alcohol, one more drink could send you into this negative zone because it actually hurts you. - Marginal utility most of the time will not go negative, but the graph can leave the quadrant and go into the quadrant below Maximizing Utility Within Constraints - Remember that question that made you look at marginal benefits and costs of studying for Bio and Econ (something like that) - So this is basically the same, except with marginal utility - If you are deciding whether to read or draw, you could potentially do both, so measure change in marginal utility - There are many things people would like to do, but there are time and money constraints - Budget Constraint- a line that is composed of all the possible combinations of goods and services that a consumer can buy with his or her income - A rational thinker should spend the budget in a way that gets the highest possible utility - Would you get more utility from working hard and having a lot of money or having free time? (Food for thought) Responding to Changes in Income and Prices - When income increases, more bundles become affordable (vice versa) - To show this, we shift the budget line (this is basically a specific demand curve that compares two goods rather than price and quantity) - When price changes, but income stays the same we have two affects 1. Income Effect- the change in consumption that results from increased effective wealth due to lower prices. The good is what is changing so Cody will appear richer. To show this, we will actually rotate the budget line to show only one good is moving. 2. Substitution Effect- the change in consumption that results from a change in the relative price of goods. So let’s say you are buying DVDs and CDs (I know, throwback). CD’s are 10 dollars and DVDs are 20. I DVD means you are giving up a chance to buy two CDs. Well if CDs drop to 5 dollars, you are giving up an opportunity to buy 4 CDs if you buy a DVD - Veblen Goods- items that have a higher quantity demanded when price is higher - People buy them because they are flashy (Gucci, Ferrari) and they get utility out of people’s reactions to them owning them Utility and Society - People can get utility for lots of reasons (some aren’t so obvious) - For status: Utility is a combination of outside perceptions and inner preferences - You might choose to buy the brand name shoes because everyone will know and judge you if you wear knockoffs (this is why people will pay for the logo) - Frame of reference- we may choose the option to be the richest of our co workers rather than the poorest, even if the second option is a higher paying job - Altruism- a motive for action in which a person’s utility increases simply because someone else’s utility increases - Reciprocity- responding to another’s action with a similar action - If someone is kind to you, you will be kind back to them - Negative reciprocity- when you intend to decrease someone’s utility in response to being harmed (sabotage) It’s a pretty straight-forward chapter, because it is so subjective. But like always, email me with questions.


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