ECON 010 CHAPTER 10 Lecture: Consumer decision making Full rationality Utility: enjoyment from consumption, a number in economics

(the higher the better) Example: $10 in your pocket. Spend it on Coke and/or Pizza. We must consider utility and price of both. Budget = $10 Utility of Pizza: Utility of Coke: Price = $2 Price = $1 Quantity Utility 0 1 2 3 4 5 6 0 20 36 46 52 54 51 Quantity Utility 0 1 2 3 4 5 6 0 20 35 45 50 53 52

1. Maximizing Total Utility of C & P 2. Spending the entire $10 Marginal utility: the enjoyment we get from consuming the next unit Pizza Coke Quantity 0 1 2 3 4 5 6 Utility 0 20 36 46 52 54 51 Marginal Utility 0 20 16 10 6 2 -3 MU/$ 0 19 8 5 3 1 -1.5 0 1 2 3 4 5 6 0 20 35 45 50 53 52 Quantity Utility Marginal Utility 0 20 15 10 5 3 -1 MU/$ 0 20 15 10 5 3 -1

Goal: Equalize MU/$ given our budget. MU pizza / P pizza = MU coke / P coke Rationality 3 slices of pizza + 4 cans of coke MU/$ pizza = 5 = MU/$ coke = 5

Derive the demand curve: General idea:

We derive the demand curve by changing the price and calculating the optimal quantity.

Rational consumer makes choices by equating marginal utility per dollar across goods. MUA/PA = MUB/PB=MUC/PC

Reading: Technology is the processes a firm uses to turn inputs into outputs of goods and services. Technological change is a change in the ability of a firm to produce a given level of output with a given quantity of inputs. The short run is the period of time during which at least one of a firms inputs is fixed. The long run is the period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant. o 2 inputs: capital (K) and labor (L) o In the SR, K is fixed and L is variable. o In the LR, K and L are variable. Total cost is the cost of all the inputs a firm uses in production. Variable costs are costs that change as output changes; cost of variable inputs. o In the SR, this is the cost of labor. Fixed costs are costs that remain constant as output changes; cost of fixed inputs.

o In the SR, this is the cost of capital. Total Cost = Fixed Cost + Variable Cost Opportunity cost is the highest-valued alternative that must be given up to engage in an activity. Explicit cost is a cost that involves spending money. Implicit cost is a nonmonetary opportunity cost. The production function is the relationship between the inputs employed by a firm and the maximum output it can produce with those inputs. The average total cost is total cost divided by the quantity of output produced. The marginal product of labor is the additional output a firm produces as a result of hiring one more worker. The law of diminishing returns is the principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline. The average product of labor is the total output produced by a firm divided by the quantity of workers. o The average product of labor is the average of the marginal products of labor. Marginal cost is the change in a firms total cost from producing one more unit of a good or service. o When the marginal product of labor is rising, the marginal cost of output is falling. When the marginal product of labor is falling, the marginal cost of production is rising. o We can conclude that the marginal cost of production falls and then rises forming a U shape because the marginal product of labor rises and then falls. Average fixed cost is fixed cost divided by the quantity of output produced. Average variable cost is variable cost divided by the quantity of output produced. Long-run average cost curve is a curve showing the lowest cost at which a firm is able to produce a given quantity of output in the long run, when no inputs are fixed. Economies of scale is the situation when a firms long-run average costs fall as it increases output. Constant returns to scale is the situation when a firms long-run average costs remain unchanged as it increases output. Minimum efficient scale is the level of output at which all economies of scale are exhausted. Diseconomies of scale is the situation when a firms long-run average costs rise as the firm increases output.