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CHAPTER 5 THE THEORY OFCONSUMER BEHAVIOUR

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1. Cardinal %tility &heory2. &otal and Marginal %tility

'. &he La o" (i#inishing Marginal %tility

4. Consu#er )*uilibriu# + Mathe#atical Method

. -rdinal %tility &heory. &he /udget Line

. &he ndi""erence Curve

. Consu#er )*uilibriu# + 3raphical Method

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&able o" Content

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- The paradox: Water is cheap and diamonds are expensive!

- The observation that things that have the greatest value

in use sometimes have little value in exchange and things

that have little value in use sometimes have the greatest

value in exchange.

- How can this be explained???

- Utility theory provides a solution!




(AM-($5A&)R 6ARA(-7

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.1 CAR(AL %&L&8 &9)-R8

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%tility is a #easure o" the satis"action,happiness, or bene"it that results "ro# theconsu#ption o" a good.

A util is an arti"icial construct used to #easureutility.

&otal utility is the total satis"action a personreceives "ro# consu#ing a particular *uantity o"

a good.Marginal utility is the additional utility a person

receives "ro# consu#ing an additional unit o" aparticular good.

%tility &heory

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&he #arginal utility gained by consu#ing e*ual

successive units o" a good ill decline as the

a#ount consu#ed increases.

&he total utility o" so#ething can be rising as the#arginal utility o" that so#ething is "alling.

La o" (i#inishing

Marginal %tility

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&otal %tility, Marginal %tility, and the La o"

(i#inishing Marginal %tility

Both total utility and marginal utility are

expressed in utils.Marginal utility is the change in totalutility divided by the change in thequantity consumed of the good, MU =

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&otal %tility, Marginal %tility, and the La o"

(i#inishing Marginal %tility

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&he la o" di#inishing #arginal utility is basedon the idea that i" a good has a variety o" usesbut only 1 unit o" the good is available, then the

consu#er ill use the "irst unit to satis"y his orher #ost urgent ant.

" 2 units are available, the consu#er ill use thesecond unit to satis"y a less urgent ant.

La o" (i#inishing Marginal %tility +

Application

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•Co#paring the utility one person receives "ro# a good,

service, or activity ith the utility another person receives

"ro# the sa#e good, service, or activity.




nterpersonal %tility Co#parison

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o nterpersonal %tility Co#parison

Caution= &he utility obtained by one person cannot be

scienti"ically or ob>ectively co#pared ith the utility

obtained "ro# the sa#e thing by another person because

utility is sub>ective.




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•&he total utility o" ater is high because ater is e!tre#elyuse"ul.

• &he total utility o" dia#onds is lo in co#parison because

dia#onds are not as use"ul as ater.

•&he #arginal utility o" ater is lo because ater is soplenti"ul that people end up consu#ing it at lo #arginal

utility.

• &he #arginal utility o" dia#onds is high because dia#onds

are so scarce that people end up consu#ing the# at high

#arginal utility.

• (o prices re"lect total or #arginal utility? @@@@@@@@@@@




(ia#ond$5ater 6arado! Resolved

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&he analysis is based on the assu#ption that

individuals see: to #a!i#ie utility.

-ccurs hen the consu#er has spent all inco#e

and the #arginal utilities per dollar spent oneach good purchased are e*ual=

Consu#er )*uilibriu# + Mathe#atical

Method

where the letters A–Zrepresent all the goods aperson buys.

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Marginal utility analysis can be used to illustrate the la

o" de#and, hich states that price and *uantity

de#anded are inversely related, ceteris paribus.

Btarting "ro# consu#er e*uilibriu# in a orld containing

only to goods, A and /, a "all in the price o" A ill cause

MU A P A to be greater than MU B P B.

As a result, the consu#er ill purchase #ore o" good A

to restore hersel" to e*uilibriu#.

Marginal %tility Analysis and the La o"

(e#and

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•/udget lineconstraint D/CE=all the co#binations or

bundles

o" to goods a person can

purchase given a certain#oney

inco#e and prices "or the

to goods.

• Blope o" /C= represent the

relative prices o" to goods

D6!6yE




-R(AL %&L&8 &9)-R8

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•ndierence set: group o bundles o two goods that give anindividual e"ual total utility.

• ndierence #urve: represent an indierence set. $ curve

that shows all the bundles o two goods that give an

individual e"ual total utility.• #haracteristics o # that are consistent with reasonable

assumption about consumer behaviour.

%a& downward sloping

%b&convex to the origin

%c&arther rom the origin are preerable

%d& do not cross %intersect&




ndi""erence Curve DCE

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•C) e!ists at the point here the slope o" the /C F theslope o" an C




Consu#er )*uilibriu# DC)E$ 3raphical

Method

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Topic 5 BEEB1013

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