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Chapter 21:
Consumer Choice
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
2
Utility Theory Utility
The want-satisfying power of a good or service
Utility Analysis The analysis of consumer decision making based
on utility maximization Util
A representative unit by which utilityis measured
3
Utility Theory
Marginal UtilityThe change in total utility due to
a one-unit change in the quantity of a good or service consumed
Marginal utility =change in total utility
change in number of units consumed
4
Total and Marginal Utilityof Watching DVDs
Figure 20-1, Panel (a)
5
Total and Marginal Utilityof Watching DVDs
Total utility ismaximized...
…where marginalutility equals zero.
Mar
gina
l Util
ity (
utils
per
wee
k)0
1 2 3 5 6 7
-4
-2
2
4
6
8
10
DVDs Watched per Week
4
DVDs Watched per Week
Tot
al U
tility
(ut
ils p
er w
eek
)
0 1 2 3 4 5 6 7
2
4
6
8
10
12
14
16
18
20
Figure 20-1, Panels (b) and (c)
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Total and Marginal Utilityof Watching Videos Observations
Marginal utility falls as more is consumed Marginal utility equals zero when total utility
is at its maximum
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Diminishing Marginal Utility
Diminishing Marginal UtilityThe principle that as more of any good
or service is consumed, its extra benefit declines
Increases in total utility from consumption of a good or service become smaller and smaller as more is consumed during a given time period
8
Consumer OptimumA choice of a set of goods and services that
maximizes the level of satisfaction for each consumer, subject to limited income
Optimizing Consumption Choices
9
Total Utility Marginal UtilityDVDs of DVDs per Marginal Utility per Dollar
per Period (utils) Spent (MUd/Pd)Period (utils) MUd (Price = $5)
0 0.0 —— ——
1 50.0 50.0 10.0
2 95.0 45.0 9.0
3 135.0 40.0 8.0
4 171.5 36.5 7.3
5 200.0 28.5 5.7
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26
Table 20-1
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Total Utility Marginal UtilityPizza Slices of Pizza Slices Marginal Utility per Dollar
per per Period (utils) Spent (MUpPp)
Period (utils) MUp (price = $3)
0 0.0 —— ——
1 25 25 8.3
2 47 22 7.3
3 65 18 6.0
4 80 15 5.0
5 89 9 3.0
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26
Table 20-1
11
0 —— ——
1 10.0 8.3
2 9.0 7.3
3 8.0 6.0
4 7.3 5.0
5 5.7 3.0
Marginal Utility Marginal UtilityItems per Dollar per Dollarper Spent (DVD) Spent (Pizza)
Period (price = $5) (price = $3)
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26
Table 20-1
12
First DVD $26 - $5 = $21
Second DVD $21 - $5 = $16
First pizza slice $16 - $3 = $13
Third DVD $13 - $5 = $ 8
Fourth DVD and $8 - $5 = $ 3
Second pizza slice $3 - $3 = $ 0
Buying Decision Remaining Income
Steps to Consumer Optimum
Table 20-2
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Optimizing Consumption Choices
A little mathThe rule of equal marginal utilities
per dollar spent A consumer maximizes personal satisfaction when
allocating money income in such a way that the last dollars spent on good A, good B, good C, and so on yield equal amounts of marginal utility
14
A little mathThe rule of equal marginal utilities per dollar
spent
Optimizing Consumption Choices
MU of good Aprice of good A
=MU of good B
price of good BMU of good Z
price of good Z= =...
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How a Price ChangeAffects Consumer Optimum
Income = $26
Qd = 4MUd
Pd
36.55
= = 7.3
Qp = 2MUp
Pp
223
= = 7.3
16
How a Price ChangeAffects Consumer Optimum
Assume Price of DVDs Falls to $4
Qd = 4MUd
Pd
36.54
= = 9.13
Qp = 2MUp
Pp
223
= = 7.3
17
How a Price ChangeAffects Consumer Optimum
Assume Price of DVDs Falls to $4
Result Buy more DVDs and MUd falls
NowMUd
Pd
>MUp
Pp
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DVD Rental Pricesand Marginal Utility
Figure 20-2
3
DVD Rentals per Week
D
210
4
5
Pric
e pe
r U
nit (
$ pe
r D
VD
)
B
A
19
How a Price ChangeAffects Consumer Optimum The Substitution Effect
The tendency of people to substitute cheaper commodities for more expensive commodities
Purchasing PowerThe value of money for buying goods and
services Real-Income Effect
The change in people’s purchasing power that occurs when, other things being constant, the price of one good that they purchase changes
Chapter 21:
Consumer Choice
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
Appendix E
Indifference Curve Analysis
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
Figure E-1 Combinations That Yield Equal Levels of Satisfaction
Figure E-2 Indifference Curves: Impossibility of an Upward Slope
Figure E-3 Implications of a Straight-Line Indifference Curve
Table E-1 Calculating the Marginal Rate of Substitution
Figure E-4 A Set of Indifference Curves
Figure E-5 The Budget Constraint
Figure E-6 Consumer Optimum
Deriving Demand Curve from Indifference Analysis
If the price of meals drops, the consumer can buy more. The Budget Constraint shifts outward along the meals axis. The new point of indifference will be at a higher quantity per week. Thus, lower P, higher QD.
Appendix E
Indifference Curve Analysis
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
