Chapter 6Chapter 6

Consumer Choice and DemandConsumer Choice and DemandConsumer Choice and DemandConsumer Choice and Demand

Utility AnalysisUtility Analysis

• The utility or satisfaction, you derive from consumption of a good or service.– It cannot be compared with another person’s

experience.

Tastes and PreferencesTastes and Preferences

• Utility: the sense of pleasure or satisfaction.– It is subjective.– It depends on YOUR taste and preferences.– Assumption that tastes are given and relatively

stable.

The Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility

• Total utility- the total satisfaction you derive from consumption.

• Marginal utility- the change in total utility resulting from a one-unit change in consumption.

The Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility

The more of a good consumed The smaller the increase in total utility

Marginal utility from each additional unit Declines as more is consumed

Disutility Negative marginal utility

“Been there; done that”

Measuring UtilityMeasuring Utility

• Units of Utility– It is more details on how much you enjoyed your

consumption.

• Each person has a uniquely subjective utility scale.

LO2 Utility Derived from Drinking

Water After Jogging Four Miles

Exhibit 1

LO2

Total Utility and Marginal Utility You Derive from Drinking Water after Jogging Four Miles

Total utility increases with each of the first 4 glasses of water consumed but by smaller and smaller amounts

The 5th glass causes TU to fall

Marginal utility declines

MU of the 5th glass is negative

Exhibit 2

5

Glasses (8-ounce)

43210

20

40

60

80

Tot

al u

tility

(a) Total utility (b) Marginal utility

5

Glasses (8-ounce)

4321

0

20

40

Mar

gina

l util

ity

Utility Maximization in a World without Scarcity

Utility Maximization in a World without Scarcity

• Free good– Increase consumption as long as marginal utility is

positive.

• What if there are two goods?– Consume until the marginal utility of each is zero.

LO2

Total and Marginal Utilities from Pizza and Videos

Exhibit 3

Utility Maximization in a World of Scarcity

Utility Maximization in a World of Scarcity

• Goods are not free• Limited income now

– What do we do?• We find an equilibrium.

Utility Maximizing ConditionsUtility Maximizing Conditions

• Once a consumer is in equilibrium there is no way to increase utility by reallocating the budget.

• Consumer equilibrium is achieved when the budget is exhausted and the last dollar spent on each good yields the same MU.– The consumer gets the same bang from the last

buck spent on each good.

Utility Maximizing ConditionsUtility Maximizing Conditions

y

y

x

x

p

MU

p

MU

Example of Consumer Equilibrium

Consumer SurplusConsumer Surplus

– Value of a good purchased must at least equal the Price

Demand curve– Marginal valuation

Consumer surplus– Consumer bonus– Value of total utility minus total spending– Area under Demand curve, above Price

LO3

Consumer Surplus from Sub Sandwiches

D

2

4

6

$8

Pric

e pe

r su

bs

7

5

3

1

Subs per

month3210 4 5 6 7 8

At P=$4:

•1st sub valued at $7

•2nd sub valued at $6

•3rd sub valued at $5

•4th sub valued at $4

•Willing to pay $22 for 4 subs

•Pays only $16 for 4 subs

•Consumer surplus

$22-$16 = $6

When P drops to $3, consumer surplus increases by $4

Exhibit 6

Market Demand and Consumer Surplus

Market Demand and Consumer Surplus

Market Demand curve– Horizontal sum of individual Demand curves – Total quantity demanded, per period, by all

consumers, at various prices Consumer surplus for the market

– Amount consumers are willing to pay minus amount they pay

– Net benefit for consumers– Economic welfare

LO3

Summing Individual Demand Curves to Derive Market Demand for Sub Sandwiches

0 2 4 6

Pric

e

2

4

$6

dY

(a) You

0 2 4

2

4

$6

dB

(b) Brittany

Subs per month

0 2

2

4

$6

dC

(c) Chris

0 2 6 12

2

4

$6

dY+dB+dC=D

(d) Market demand for subs

Market demand curve is the horizontal sum of individual demand curves

Exhibit 7

LO3

Market Demand and Consumers Surplus

0 Quantity per period

D1

$2

Pric

e pe

r un

it

Consumer surplus at a price of $2 is shown by the blue area.

If the price falls to $1, consumer surplus increases to include the green area.

At a zero price, consumer surplus increases to the entire area under the D curve.E

xhibit 8

Role of Time in DemandRole of Time in Demand Consumption

– Money price– Time price

Willing to pay premium for time-saving goods