Upload
ravichander-reddy
View
227
Download
0
Embed Size (px)
Citation preview
8/4/2019 Marg Util Power Point
1/63
Chapter 5 Marginal Utility and
Consumer Choice
ByRavichander Reddy
8/4/2019 Marg Util Power Point
2/63
2
Economic Principles
Total Utility and Marginal Utility Law of Diminishing Marginal Utility Relationship Between the Law of Demand
and the Marginal-Utility-To-Price Ratio Consumer Surplus Difficulties with Interpersonal Comparison
of Utility
8/4/2019 Marg Util Power Point
3/63
3
What is Marginal Utility?
Util :
It is a hypothetical unit used to
measure how much utility a personobtains from consuming a good.
8/4/2019 Marg Util Power Point
4/63
4
What is Marginal Utility?
Utility measures the satisfactionor enjoyment a person obtainsfrom consuming a good.
8/4/2019 Marg Util Power Point
5/63
5
What is Marginal Utility?
Law of Diminishing Marginal Utility :
It is the idea that as more of a good is
consumed, the utility a person derivesfrom each additional unit diminishes.
8/4/2019 Marg Util Power Point
6/63
6
What is Marginal Utility?
The implication of someoneexperiencing increasing marginalutility for pizza slices is:
The next slice of pizza would generatehigher marginal utility than the one before.
8/4/2019 Marg Util Power Point
7/63
8/4/2019 Marg Util Power Point
8/63
8
What is Marginal Utility?
The implication of someoneexperiencing increasing marginalutility for pizza slices is:
It is not clear that someone could survive
having increasing marginal utility!
8/4/2019 Marg Util Power Point
9/63
9
What is Marginal Utility?
It possible for marginal
utility to become negative. For example, if you overeat and feel
ill, then the marginal utility for the lastbit of food you ate is negative.
8/4/2019 Marg Util Power Point
10/63
10
What is Marginal Utility? A rational consumer will not knowingly pay to buy a unit of a good that generates negativemarginal utility.
Presumably something else could be bought
that generates positive marginal utility. Buying something that generates negativemarginal utility is not consistent with utilitymaximization.
8/4/2019 Marg Util Power Point
11/63
11
EXHIBIT 1 TOTAL UTILITY AND MARGINAL UTILITYDERIVED FROM CONSUMING T-BONESTEAKS (UTILS)
8/4/2019 Marg Util Power Point
12/63
8/4/2019 Marg Util Power Point
13/63
8/4/2019 Marg Util Power Point
14/63
14
EXHIBIT 2A TOTAL AND MARGINAL UTILITY
8/4/2019 Marg Util Power Point
15/63
15
EXHIBIT 2B TOTAL AND MARGINAL UTILITY
8/4/2019 Marg Util Power Point
16/63
16
Exhibit 2: Total andMarginal Utility
In Exhibit 2, the curves in
Panel a and b represent: The curve in Panel a is the total utility
curve for T-bone steaks. Panel a depicts the number of utils, orthe amount of utility, a person gains fromconsuming a certain number of steaks.
8/4/2019 Marg Util Power Point
17/63
17
Exhibit 2: Total andMarginal Utility
In Exhibit 2, the curves in
Panel a and b represent: Total utility peaks at 81 utils, or 5 steaks.Each steak consumed beyond 5 reducestotal utility.
8/4/2019 Marg Util Power Point
18/63
18
Exhibit 2: Total andMarginal Utility
In Exhibit 2, the curves in
Panel a and b represent: The curve in Panel b is the marginal utility curve for T-bone steaks. The curve depicts the change in totalutility a person derives from consumingeach additional steak.
8/4/2019 Marg Util Power Point
19/63
19
Exhibit 2: Total andMarginal Utility
In Exhibit 2, the curves in
Panel a and b represent: When marginal utility is zero, total utilityis maximized.
8/4/2019 Marg Util Power Point
20/63
20
What is Marginal Utility?
If water is necessary for life, thenthe market price of water so much
lower than for diamonds because: Market price reflects marginal utility,not total utility. Due to the law of diminishing marginal utilityand the abundance of water, the marginalutility of water is lower than for diamonds.
8/4/2019 Marg Util Power Point
21/63
21
What is Marginal Utility?
A hypothetical circumstance inwhich the marginal utility of
water might exceed the marginalutility of a diamond:
If you are lost in the desert and areseverely dehydrated, then your marginalutility for a gallon of water might exceedyour marginal utility for a diamond.
8/4/2019 Marg Util Power Point
22/63
22
French Cuisine and MarginalUtility
Many courses, each with small portionsof food (French cuisine), may generatemore utility than one course with alarge portion of food because:
One large portion will drive down marginalutility. Marginal utility is high for the whole meal.
8/4/2019 Marg Util Power Point
23/63
23
EXHIBIT 3 MARGINAL UTILITIES OF CLOTHES ANDAMUSEMENT GOODS (UTILS)
8/4/2019 Marg Util Power Point
24/63
24
Exhibit 3: Marginal Utilities of Clothes andAmusement Goods (Utils)
Based on the utility data in Exhibit3, a rational consumer will select thebest combination of clothes andamusement goods:
By sequentially picking units of clothingand amusement goods that generate thelargest MU/P.
8/4/2019 Marg Util Power Point
25/63
25
EXHIBIT 4 MARGINAL-UTILITY-TO-PRICE RATIOS OFCLOTHES AND AMUSEMENT GOODS (MU/P)
8/4/2019 Marg Util Power Point
26/63
26
Exhibit 4: Marginal-Utility-to-Price Ratiosof Clothes and Amusement Goods (MU/P)
If a unit of clothes and amusementgoods both cost $10, and if you have$80 to spend, the rational consumerwill spend her money:
MU/P is equal when three units of clothes and five units of amusementgoods are purchased ( MU/P = 1.4).
8/4/2019 Marg Util Power Point
27/63
27
Marginal-Utility-to-Price Ratio
Marginal-utility-to-price ratio :
The ratio is calculated by dividingthe marginal utility of a good by theprice of the good -- MU/P .
8/4/2019 Marg Util Power Point
28/63
28
Marginal-Utility-to-Price Ratio
The MU/P equalization principle :
A persons total utility is maximizedwhen the ratios of marginal utility to
price for the last unit of each of the goodsconsumed are equal.
8/4/2019 Marg Util Power Point
29/63
29
Marginal-Utility-to-Price Ratio
The MU/P equalization principle : MU/P measures marginal utility per dollarspent.
Total utility will be maximized (within theconstraints of a limited budget) when eachindividual purchase generates the largestpossible MU/P .
8/4/2019 Marg Util Power Point
30/63
30
Marginal-Utility-to-Price Ratio
The MU/P equalization principle :
A rational and fully-informed consumer willalways shift a dollar from a good whose MU/P
is lower to one whose MU/P is higher, if such ashift is possible.
8/4/2019 Marg Util Power Point
31/63
31
Marginal-Utility-to-Price Ratio
The MU/P equalization principle :
The principle is based on consumer behavior. Consumers will always arrange theirsequence of choices among goods starting withthe highest MU/P and running down to exhaustan expenditure budget.
8/4/2019 Marg Util Power Point
32/63
32
Marginal-Utility-to-Price Ratio
The MU/P equalization principle : The consumer choice process is inequilibrium when:
There is no longer any incentive for theconsumer to rearrange her purchases. The MU/P is equal for the last unitof each good or service consumed.
8/4/2019 Marg Util Power Point
33/63
33
EXHIBIT 5 COMPARING MU/P s AFTER A 20-PERCENT-OFF SALE ON CLOTHES
8/4/2019 Marg Util Power Point
34/63
34
Exhibit 5: Comparing MU/Ps After a 20Percent Off Sale on Clothes
The MU/P of clothes changes
when there is a 20 percent off sale on clothes by: MU/P for each unit of clothing rises whenprice is reduced by 20 percent. This will cause a rational consumerto consume more clothes.
8/4/2019 Marg Util Power Point
35/63
35
EXHIBIT 6 COMPARING MU/P s AFTER A 50-PERCENT-OFF SALE ON CLOTHES
8/4/2019 Marg Util Power Point
36/63
36
Exhibit 6: Comparing MU/Ps After a 50Percent Off Sale on Clothes
An additional reduction in the priceof clothing will change all of the
MU/Ps for clothing, and thus changea rational consumers consumptionof clothing.
If the price of clothes falls again, from $8to $5, the quantity of clothing demandedincreases from four to six units.
8/4/2019 Marg Util Power Point
37/63
37
EXHIBIT 7 THE DEMAND CURVE FOR CLOTHES
8/4/2019 Marg Util Power Point
38/63
38
Exhibit 7: The Demand Curve for Clothes
When the price of clothing fallsfrom $10 to $8 to $5, which of thefollowing occurs:
Quantity demanded remains the same. Quantity demanded falls from 6 to 4 to 3. Quantity demanded rises from 3 to 4 to 6.
8/4/2019 Marg Util Power Point
39/63
39
Exhibit 7: The Demand Curve for Clothes
When the price of clothing fallsfrom $10 to $8 to $5, which of thefollowing occurs:
Quantity demanded remains the same. Quantity demanded falls from 6 to 4 to 3. Quantity demanded rises from 3 to 4 to 6.
8/4/2019 Marg Util Power Point
40/63
40
MU/P Equalization Principleand the Law of Demand
Changes in the marginal-utility-
to-price ratio are caused by: A change in the marginal utility of a goodor a change in the price of a good changes
the marginal-utility-to-price ratio, andtherefore changes quantity demanded.
8/4/2019 Marg Util Power Point
41/63
41
MU/P Equalization Principleand the Law of Demand
The relationship between the MU/P
Principle and the Law of Demand: If the price of a good falls: MU/P rises. The rational consumer will increase herconsumption of that good. Increase in quantity demanded (movement
along the demand curve).
8/4/2019 Marg Util Power Point
42/63
42
MU/P Equalization Principleand the Law of Demand
The relationship between the MU/P
Principle and the Law of Demand: If consumer preference for a good decreases: MU/P declines. The rational consumer will reduceconsumption. The demand curve shifts to the left (sinceconsumer preference is a non-price factor).
8/4/2019 Marg Util Power Point
43/63
43
MU/P Equalization Principleand the Law of Demand
The relationship between the MU/P
Principle and the Law of Demand: If consumer income increases: The consumer can pursue a lower MU/P . The consumer can afford to increaseconsumption. An increase in the demand for normal goods .
8/4/2019 Marg Util Power Point
44/63
44
MU/P Equalization Principleand the Law of Demand
A downward-sloping demand
curve is consistent with the lawof diminishing marginal utility.
Diminishing marginal utilitymeans that MU/P declines asquantity consumed increases .
8/4/2019 Marg Util Power Point
45/63
45
MU/P Equalization Principleand the Law of Demand
A downward-sloping demand
curve is consistent with the lawof diminishing marginal utility.
A consumers willingness -to-pay falls as quantity consumedincreases .
8/4/2019 Marg Util Power Point
46/63
46
Are White Rats RationalConsumers?
There is evidence that lab ratsmake consumer choices basedon MU/P.
Economists Battalio and Kagel foundthat white lab rats respond to price andincome changes in a manner consistentwith economic theory.
8/4/2019 Marg Util Power Point
47/63
47
The MU/P Guide to AuctionBidding
MU/P can help guide auction bidding:
If a particular MU/P is guaranteed bybuying something outside of the auction,and if the marginal utility from the auctiongood is known, then you can figure outyour maximum auction price.
8/4/2019 Marg Util Power Point
48/63
48
Creating Consumer Surplus
Consumer surplus : The difference between the maximum price aperson would be willing to pay for a good orservice, and the price the person actually pays. Most consumers receive some consumersurplus from a transaction.
8/4/2019 Marg Util Power Point
49/63
49
Creating Consumer Surplus
When market price falls,consumer surplus increases .
8/4/2019 Marg Util Power Point
50/63
50
Creating Consumer Surplus
If the price of a good is greater
than amount a consumer is willingto pay for that good, the consumersurplus will be negative if theconsumer buys the good.
8/4/2019 Marg Util Power Point
51/63
51
Creating Consumer Surplus
A rational consumer will not
purchase a good that generatesnegative consumer surplus. A rational consumer will prefer zeroconsumer surplus (no purchase) tonegative consumer surplus.
EXHIBIT 8 THE MARKET FOR HORSEBACK RIDING
8/4/2019 Marg Util Power Point
52/63
52
EXHIBIT 8 THE MARKET FOR HORSEBACK RIDING
8/4/2019 Marg Util Power Point
53/63
53
Exhibit 8: The Market forHorseback Riding
Exhibit 8 depicts the demand andsupply curves for horseback riding.
The concept of consumer surplusapplies to horseback riding:
At a price of $6, all consumers with awillingness-to-pay value of $6 or more willpurchase a horseback ride. These consumers receive consumer surplus.
8/4/2019 Marg Util Power Point
54/63
54
Exhibit 8: The Market forHorseback Riding
Exhibit 8 depicts the demand andsupply curves for horseback riding.
The concept of consumer surplusapplies to horseback riding:
Some consumer may be willing to pay $10for a horseback ride. This consumer will receive $(10-6) = $4of consumer surplus.
8/4/2019 Marg Util Power Point
55/63
55
Exhibit 8: The Market forHorseback Riding
Exhibit 8 depicts the demand andsupply curves for horseback riding.
The concept of consumer surplusapplies to horseback riding:
A consumer who has a willingness-to-payvalue less than $6:
A rational consumer will not choose to
purchase a ride.
This consumer has a negative consumer surplus.
EXHIBIT 9 CONSUMER SURPLUS ON THE HORSEBACK
8/4/2019 Marg Util Power Point
56/63
56
EXHIBIT 9 CONSUMER SURPLUS ON THE HORSEBACK-RIDING MARKET
8/4/2019 Marg Util Power Point
57/63
57
Exhibit 9: Consumer Surplus onthe Horseback-Riding Market
Kims consumer surplus fromhorseback riding is:
$(15-6) for the first ride.
$(12-6) for the second ride.
$(9-6) for the third ride. $(6-6) for the fourth ride. These sum to $(9+6+3+0) = $18.
8/4/2019 Marg Util Power Point
58/63
58
Exhibit 9: Consumer Surplus onthe Horseback-Riding Market
Tonys consumer surplus fromhorseback riding is:
$(10-6) for the first ride. $(8-6) for the second ride.
$(6-6) for the fourth ride. These sum to $(4+2+0) = $6.
8/4/2019 Marg Util Power Point
59/63
59
Exhibit 9: Consumer Surplus onthe Horseback-Riding Market
Randys consumer surplusfrom horseback riding is:
$(9-6) for the first ride. $(6-6) for the fourth ride.
These sum to $(3+0) = $3.
8/4/2019 Marg Util Power Point
60/63
60
Exhibit 9: Consumer Surplus onthe Horseback-Riding Market
If Kim, Tony and Randy represent theentire market demand for horsebackriding, the total consumer surplus is:
$18 (Kim) + $6 (Tony) + $3 (Randy)
= $27 in consumer surplus
I l C i
8/4/2019 Marg Util Power Point
61/63
61
Interpersonal Comparisonsof Utility
An interpersonal comparison of utility :
It is a comparison of the marginalutilities that different people derive
from a good or a dollar.
I t l C i
8/4/2019 Marg Util Power Point
62/63
62
Interpersonal Comparisonsof Utility
Is it actually possible to compare thesatisfaction that different peoplederive from a good or a dollar?
It is not possible to make an exact comparison of different peoplesutility.
I t l C i
8/4/2019 Marg Util Power Point
63/63
Interpersonal Comparisonsof Utility
Is it actually possible to compare thesatisfaction that different peoplederive from a good or a dollar? Policies such as those aimed at povertyalleviation rely on society being able to makeapproximate or reasonable comparisons of utility across different people.