Chapter 21 - Consumer Choice1 Learning Objectives Distinguish between total utility and marginal...

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Chapter 21 - Consumer Choice 1 Learning Objectives Distinguish between total utility and marginal utility Discuss why marginal utility at first rises but ultimately tends to decline as a person consumes more of a good or service Explain why an individual’s optimal choice of how much to consume of each good or service entails equalizing the marginal utility per dollar spent across all goods and services

Transcript of Chapter 21 - Consumer Choice1 Learning Objectives Distinguish between total utility and marginal...

Page 1: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 1

Learning Objectives

Distinguish between total utility and marginal utility

Discuss why marginal utility at first rises but ultimately tends to decline as a person consumes more of a good or service

Explain why an individual’s optimal choice of how much to consume of each good or service entails equalizing the marginal utility per dollar spent across all goods and services

Page 2: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 2

Learning Objectives

Describe the substitution effect of a price change on the quantity demanded of a good or service

Understand how the real-income effect of a price change affects the quantity demanded a good or service

Evaluate why the price of diamonds is so much higher than the price of water even though people cannot survive long without water

Page 3: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 3

Did You Know That...

There has been a proliferation of choices at U.S. grocery stores, which now stock an average of 40,000 items?

One way of deriving the law of demand involves an analysis of the logic of consumer choice in a world of limited resources?

In this chapter we discuss what is called utility analysis.

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Chapter 21 - Consumer Choice 4

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 utility is measured

Page 5: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 5

Utility Theory

Marginal Utility

– The 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

Page 6: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 6

Graphical Analysis

We can appreciate total and marginal utility by using graphical analysis.

Page 7: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 7

Total and Marginal Utility of Downloading and Listening to Digital

Music Albums

Page 8: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 8

Total and Marginal Utility of Downloading and Listening to Digital

Music Albums

Page 9: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 9

Total and Marginal Utility of Downloading and Listening to Digital

Music Albums

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Chapter 21 - Consumer Choice 10

Total and Marginal Utility of Downloading and Listening

to Digital Music Albums

Total utility ismaximized...

…where marginalutility equals zero.

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Chapter 21 - Consumer Choice 11

Graphical Analysis

Observations

– Marginal utility falls as more is consumed.

– Marginal utility equals zero when total utility is at its maximum.

Page 12: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 12

The High Cost of Certain Sources of Negative Marginal Utility

Conventional wisdom says that it is impossible to put a price tag on happiness.

Economists usually attempt to attach dollar values to economic goods.

What is the amount of compensation required for economic “bads?”

Page 13: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 13

Diminishing Marginal Utility

Diminishing Marginal Utility

– The 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.

Page 14: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 14

Newspaper Vending Machines versus Candy Vending Machines

How many people take more than one paper from the vending machine?

Why not dispense candy the same way?

The answer is found in the concept of diminishing marginal utility.

Page 15: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 15

Optimizing Consumption Choices

Consumer Optimum

– A choice of a set of goods and services that maximizes the level of satisfaction for each consumer, subject to limited income

Page 16: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 16

Total and Marginal Utility from Consuming Music Album Downloads and Sandwiches on

an Income of $26

Page 17: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 17

Total and Marginal Utility from Consuming Music Album Downloads and Sandwiches on

an Income of $26

Page 18: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 18

Total and Marginal Utility from Consuming Music Album Downloads and Sandwiches on

an Income of $26

Page 19: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 19

Optimizing Consumption Choices

A consumer’s money income should be allocated so that the last dollar spent on each good purchased yields the same amount of marginal utility (when all income is spent), because this rule yields the largest possible total utility.

Page 20: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 20

Optimizing Consumption Choices

A little math

– The 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.

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Chapter 21 - Consumer Choice 21

A little math– The 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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Chapter 21 - Consumer Choice 22

How a Price Change Affects Consumer Optimum Recall from Table 20-1 Income = $26

Qd = 4MUd

Pd

36.55

= = 7.3

Qs = 2MUs

Ps

223

= = 7.3

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Chapter 21 - Consumer Choice 23

How a Price Change Affects Consumer OptimumAssume Price of Music Falls to $4

Qd = 4MUd

Pd

36.54

= = 9.125

Qs = 2MUs

Ps

223

= = 7.3

Page 24: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 24

How a Price Change Affects Consumer OptimumAssume Price of Music Falls to $4

Result Buy more downloads and MUd falls

NowMUd

Pd

>MUs

Ps

Page 25: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 25

How a Price Change Affects Consumer Optimum

Consumption decisions are summarized in the law of demand

– The amount purchased is inversely related to price.

A consumer’s response to a price change

– At higher consumption rate, marginal utility falls.

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Chapter 21 - Consumer Choice 26

Digital Music Download Prices and Marginal Utility

Page 27: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 27

How a Price Change Affects Consumer Optimum

The Substitution Effect

– The tendency of people to substitute cheaper commodities for more expensive commodities

Page 28: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 28

How a Price Change Affects Consumer Optimum

The Principle of Substitution

– Consumers and producers shift away from goods and resources that become priced relatively higher in favor of goods and resources that are now priced relatively lower.

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Chapter 21 - Consumer Choice 29

How a Price Change Affects Consumer Optimum

Purchasing Power

– The value of money for buying goods and services

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Chapter 21 - Consumer Choice 30

How a Price Change Affects Consumer Optimum

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

– When that price goes up (down), real income, or purchasing power, falls (increases).

Page 31: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 31

The Demand Curve Revisited

Question

– How is the demand curve derived?

Answer

– By presuming income, tastes, expectations, and the price of related goods are not changing as the price of the good changes

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Chapter 21 - Consumer Choice 32

The Demand Curve Revisited

Marginal utility, total utility, and the diamond-water paradox

– Water is essential to life but cheap.

– Diamonds are not essential to life but expensive.

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Chapter 21 - Consumer Choice 33

The Diamond-Water Paradox

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Chapter 21 - Consumer Choice 34

The Upside of Taking Off from a Less Convenient Airport

According to the principle of substitution, people shift away from consuming items that become priced relatively higher in favor of items that are now priced relatively lower.

In recent years, the principle of substitution has applied to the services offered by several major airports.

Many consumers of air travel are choosing to drive some distance before they depart to their ultimate destinations by plane.

Page 35: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 35

The Upside of Taking Off from a Less Convenient Airport

Weighing relative marginal utilities and prices

Opting to avoid hassles that reduce marginal utility

Responding to price changes

Page 36: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 36

Selected Substitute Airport Pairs in the United States

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Chapter 21 - Consumer Choice 37

Summary Discussionof Learning Objectives

Total utility versus marginal utility – Total utility is total satisfaction from

consumption.

– Marginal utility is the additional satisfaction from consuming an additional unit.

Law of diminishing marginal utility– Marginal utility ultimately declines as a person

consumes more and more of a good or service.

Page 38: Chapter 21 - Consumer Choice1 Learning Objectives  Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises.

Chapter 21 - Consumer Choice 38

Summary Discussionof Learning Objectives

The consumer optimum

– Occurs when the marginal utility per dollar spent on the last unit consumed is equalized

The substitution effect of a price change

– A person will substitute among goods by buying less of a good when its price increases.

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Chapter 21 - Consumer Choice 39

Summary Discussionof Learning Objectives

The real-income effect of a price change – A price change affects the purchasing power of

an individual’s available income.

Why the price of diamonds exceeds the price of water even though people cannot long survive without water– Marginal utility, not total utility, determines

how much people are willing to pay.