Economics Chapter 10: Consumer Choice and Behavioral Economics Essay

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Economic model of consumer behavior
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consumers will buy the combo that makes them as well off as possible from all combos budges allow them to buy
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Utility
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Enjoyment or satisfaction people receive from consumption Difficult to measure directly, economist used to try t in units of utils
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Marginal Utility
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Change in total utility a person receives from consuming one additional unit
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Total Utility
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Rises then falls as marginal utility declines until it eventually becomes negative
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Height of marginal utility curve
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Represents the change in utility as a result of consuming an additional unit
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Law of Diminishing Marginal Utility
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Principle that consumers experience diminishing additional satisfaction as they consume more during a given period of time
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Budget constraint
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Limited amount of income available to consumers to spend
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Maximize utility
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rule of equal marginal utility per dollar spent
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Consumers should consume goods up to the point where
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their marginal utilities per dollar spent are equal and the consumer is at the edge of his budget constraint, provided that Marginal utilities are not negative
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Utility Maximization formula
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MUa/Pa=MUb/Pb and Spendinga+Spendingb=Budget Constraint
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Marginal utilities per dollars spent are not equaled
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Total utility is not maximized
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Rule of equal marginal utility per dollar spent to analyze how consumers adjust buying decisions w/ price change
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Income effect Substitution effect
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Income effect
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Change in Q demanded of a good that results from the effect of a change in P of consumer purchasing power *all other factors constant
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Substitution Effect
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Change in Q demanded of a good that results from a change in price, making good more or less expensive relative to other goods, holding constant the effect of price change on consumer purchasing power. Changes the opportunity cost of consuming
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Income&Substitution effects on diff types of goods
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Normal- work together to up or down Q demanded Inferior- Income effect works in opposite direction, sub always in same direction
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Demand curve
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Plotting optimal consumption points at different prices
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Determine market demand curve
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Adding horizontally all individual demand curves
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Why is the demand curve downward sloping?
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Income and Sub effects work in same direction for normal goods or Substitution effect outweighs the income effect for most inferior goods
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Giffen Goods
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upward sloping demand curve As Q demanded increase as P rises Exceedingly rare in real life
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Social Factors
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Culture, customs, religion explain consumer choices Partly on characteristics of products, partly on how many other people are buying the product
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Celebrity endorsements
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Cause demand for a product to rise
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Network Externalities
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Usefulness increases as # of consumers increases May lead to inferior products as a result of switching costs. Make selection of products path dependent Inferior VHS systems represent market failures, fail to produce efficient output
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Fair pricing
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-Ultimatum game recipients would reject unfair allocations of $20 -Price show/game tickets below what could be charged -Buyers buy together and amount they wish to consume depends on the amount others are consuming -Business may give up some profits in short run to keep customers happy with fair prices in long run
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Behavioral Economics
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Study of situations in which people make choices that do not appear to be economically rational
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Ignoring Nonmonetary Opportunity Costs
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Endowment effect- unwilling to sell good they own even if offered a price > price they would be willing to pay Nonmonetary opportunity costs are just as real as monetary costs & should be taken into account
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Failing to ignore Sunk Costs
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Sunk Cost- Cost that has been paid and cannot be recovered Not let sunk costs impact their decision making
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Being unrealistic about Future Behavior
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Tendency to overvalue utility of current choices, ex smoking, undervalue utility received in future from choice, ex cancer Eat a lot today because expect to eat less tomorrow, underestimation of the costs of choices

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