Isn't it exciting!? In order to nicely coordinate with the way the midterm is working out, we are going to spread this unit out over a period of two weeks. The online test won't pop up until the 16th.
An interesting note: Prof Gateman thinks that population growth is the reason behind all of the world's problems.
OKAY! For this unit, we are going BEHIND the demand curve to discover what the psychological link is between consumer behavior and HAPPINESS
For instance, we will discover why the demand of a Louis Vitton Purse increases when the price increases. Sounds crazy? It might be, but it works, and we're going to find out why!
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WE'RE STARTING WITH MARGINAL UTILITY ANALYSIS
In order to add up total demand for any specific product, we set the price for the product and then add up the quantity each individual consumer demands at that price (ceteris paribus) to find the total. The total market demand is the sum of each individual household's demand for the product!
Super-easy, right?
Total demand + total supply = An economy, but we don't get to total supply until next chapter...
See, there is a chain of 'bigness'
Individual consumer preferences make up household demand
Total household demand makes up market demand
Market demand plus market supply makes up an economy
An economy is awesome and interesting
In the mean while, we need to come to understand the basis for that demand at the individual consumer level.
HOKAY, now for the juicy stuff: MARGINAL UTILITY THEORY
Utility: We define utility as satisfaction, happiness, fulfillment of a want. Sometimes utility is also used as a method ranking products, or illustrating personal preferences.
Utility is an ORDINAL MEASURE (which means that we can rank utility, but unlike a cardinal measure, we cannot assign specific numeric value to it)
TOTAL UTILITY is the total satisfaction derived from consuming all units of the good (for instance, the total amount of satisfaction I derive from chugging 10 bottles of beer)
MARGINAL (extra, or incremental) UTILITY is the change in total utility which occurs as a result of consuming one additional unit of the good (ie, the amount of satisfaction I derive from chugging the 10th bottle of beer)
There is this thing in economics, and it is known as the
LAW OF DIMINISHING MARGINAL UTILITY
What it means is that marginal utility decreases as we continue to consume a certain product AFTER A CERTAIN POINT (ceteris paribus)
SEE!?
Why does this happen?
Well, it's because of opportunity cost. Usually, consumers are willing to give up more for the first quantity of a product than the for the 39th quantity of a product. A good example here is water. We would give up a LOT in order to have use of at least 1 litre of water per day. We would give up a significantly smaller amount to have use of 390 litres of water per day.
The FORMULAS:
Marginal Utility = (Change in Total Utility)/(Change in Quantity)
Marginal Utility is a derivative of total utility with regard to quantity
Total utility = The sum of the marginal utilities
Total utility is an integral of marginal utility
Let's review:
-Total utilty increases as a decreasing rate after a certain point (ceteris paribus)
-Marginal utility is the change in total utility divided by the change in quantity
-The slope of a line between two points on a total utility curve is the marginal utility of that product for that change in quantity
-Generally, total utility curve is S-shaped
The point where marginal utility stops increasing and begins to decrease is the inflexion point.
The reason why marginal utlity rises up to the inflexion point is that usually, the first bit of a product makes you crave or require even more of it (it's psychological).
After the inflexion point, total utility can still increase, but at a decreasing rate.
So... what can we do with this knowledge?
WELL we can try and maximize our utility, given two different products at different prices.
IN ECONOMICS, WE ALWAYS ASSUME THAT INDIVIDUALS SEEK TO MAXIMIZE THEIR TOTAL UTILITY. (We call this maximization principle). Individuals prefer happiness to unhappiness.
We will prove that individuals allocate income such that the utilty gained from the last dollar spent on each good is equal. In other words, that marginal utility per price on each good is equal. This can be expressed as an equation.
(marginal utility of product 1)/(Price of Product 1) = (Marginal utility of product 2)/(Price of product 2)
WE MAXIMIZE THE TOTAL UTILITY BY EQUATING THE MARGINAL UTILITIES.
Why do we use 'per dollar' utility? Because utility gained from one very expensive product is going to be much higher than utility gained from one cheap product, so we have to accomodate for that.
In these equations, we always assume that there is no utility gained by holding on to money (unless the money is considered a good, like in currency exchange scenarios)
So just think about that for a little while...
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