Transcript utils

The Economics of
Consumers
Study Questions
1. What are the kinds of goods consumers
spend their income on?
 2. What is diminishing marginal utility?
 3. How do consumers maximize utility over
several products?
 4. What is the difference between an
inelastic demand and an elastic demand?

Study Questions
5. What is the main factor affecting supply
elasticity?
 6. Why would retailers prefer taxes to be
levied on inelastic goods rather than
elastic goods?

Income Earners
Owners of land resources – rent
 Owners of labor – wages/salary
 Owners of financial capital – interest

of capital goods – return on
investment
 Owners

Entrepreneurs – profit, if successful
What do we do with our Income?
Pay taxes.
 Save some.
 Spend the rest.

Consumer Spending
Durable goods
 Nondurable goods
 Services

Utility

This is the amount of satisfaction,
usefulness or pleasure we get from
consuming a specific item at one particular
time.
 subjective;
intensely personal and situational
 we use our value system to assign utility
Utility

Marginal utility – the added utility we will
get out of consuming one more of a good.
cost – the added cost of obtaining
one more of a good.
 Marginal

Total utility – the sum of all the utility we
obtain when we consume a series of a
good.
Diminishing Marginal Utility
As you consume more and more of a
good, your marginal utility decreases.
 As your marginal utility decreases, you
become less interested in consuming
another unit of the good.

 When
MU falls below MC, you will decide to
stop consuming more units of this good
Figure 3-1. Diminishing Marginal
Utility
utility
MU
MC
0
1
2
3
4
slices of pizza
5
6
7
Demand and Diminishing MU

If the sales person wants us to buy more
of his goods, he must offer it to us at a
lower price.
 the
added units are less valuable to us due to
diminishing MU, so we will buy them only if
they come at a lower price (MC is decreased).
Comparing Value to Price
Consumers choose from many products.
 The next item a consumer should buy is
the one with the highest MU per dollar
(MU/P) spent. This increases TU the
greatest.
 The consumer maximizes TU when the
next choices all have the same MU/P.

Utility Theory
•
The more pleasure (satisfaction, utility) we
get from a product, the higher the price we’re
willing to pay for it.
–
–
–
Utility: the pleasure or satisfaction obtained from
using a good or service.
Total utility: the amount of satisfaction obtained
from the consumption of a series of products.
Marginal utility: the change in total utility obtained
by consuming one additional (marginal) unit of a
product.
19-13
Total and Marginal Utility of Downloading
and Listening to Digital Music Albums,
Panel (a)
TU and MU
As more of a product is
consumed, Total utility
increases at a
Diminishing rate.
Tacos
consumed
in 1 meal
TU
MU
0
1
0
10
10
2
18
8
3
24
6
4
28
4
5
30
2
6
30
0
7
28
-2
TOTAL AND MARGINAL UTILITY
0
10
18
24
28
30
30
28
10
8
6
4
2
0
-2
30
Total Utility (utils)
0
1
2
3
4
5
6
7
TU
20
10
0
Marginal Utility (utils)
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
2
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
0
10
18
24
28
30
30
28
10
8
6
4
2
0
-2
30
Total Utility (utils)
0
1
2
3
4
5
6
7
TU
20
10
0
Marginal Utility (utils)
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
Observe
Diminishing
Marginal
Utility
1
2
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
7
Units consumed per meal
Utility Theory (cont'd)

Observations
 Marginal
 Marginal
utility falls as more is consumed.
utility equals zero when total utility is
at its maximum.
Diminishing Marginal Utility
As long as marginal utility > 0, total utility increases. When
marginal utility becomes negative, total utility maxes out and then
decreases.
19-19
Diminishing Marginal Utility

Law of Diminishing Marginal Utility = the
marginal utility of a good declines as more
of it is consumed in a given period of time.
As long as MU is increasing TU must be
increasing.
 When MU is not increasing (diminishing)
each unit added yields less utility

Example: Newspaper Vending
Machines versus Candy Vending
Machines

Newspaper machines do not prevent people
from taking more than one paper. Why not
dispense candy the same way?

The answer is found in the concept of
diminishing marginal utility.

Can you think of a circumstance under which a
substantial number of newspaper purchasers
might be inclined to take more than one
newspaper from a vending machine?
Optimizing Consumption
Choices
 Assumption:
Consumer is rational
Purchases with preferences in mind
Limited income
Selects best combination of goods attainable.

A choice of a set of goods and services that
maximizes the level of satisfaction for each
consumer, subject to limited income
maximization – consumers want to get the most
satisfaction from consumption choices
 Utility

Let’s look at concept of Marginal Utility per dollar
spent
Last dollar spent yields equal portions of
utility
MU of product A
Price of product A
= MU of product B
Price of product B
And the consumer’s income is all spent.
Total and Marginal Utility from
Consuming Music Album Downloads
($5) and Cappuccinos ($3) on an
Income of $26
Step one: Calculate your marginal utility (albums)
Step two: Calculate the Marginal utility/dollar
Step three: Repeat step one and two for (cappuccinos)
Step four: Look for exact or near exact amounts for MU/$
Step five: check your work – find number to purchase for both and multiply
Price and Quantity



The demand curve
slopes downward
because of diminishing
marginal utility.
In order to justify
buying more, the price
must be lower.
At $0.25, the consumer
buys 12 ounces (point
f).
19-25
Upsetting Consumer Equilibrium

Advertising:
 tries
to get us to increase our MU for its good.
 notifies us when P of its good is lower.
 both will upset consumer equilibrium.
 and we will buy more of the advertised good.
How do demand and supply change in response to
changes in price and quantity?=
Elasticity
Elasticity of Demand and Elasticity of
Supply
Bottom Line on Elasticity of Supply
If producers are relatively responsive to
price changes supply is elastic
If producers are relatively insensitive to
price changes supply is inelastic
When a large percentage change in price
brings about a small percentage change
in quantity supplied = inelastic….
(examples: Rise in costs of computers…
takes time to shift resources)
Over Time… more plants built, more
engineers trained, and more computers
supplied
When a small percentage change in price
brings about a large percentage change
in quantity supplied = elastic
Example: Cowboys beat Philadelphia
Eagles for wildcard playoff… T-shirt
producer can raise his price just a “tad”
and sell a ton more shirts…
TIME AND ELASTICITY OF SUPPLY
Ss
Sm
SL
D2
D1
D2
D2
D1
D1
Note: perfectly inelastic. (price)(quantity)
Inelastic (price) (quantity)
Elastic (price) (quantity)
See relationship between small percentage increase in P and Q that
follows.
Remember
Supplier is looking at revenue
Revenue Test = P x Q = TR
What is profit?
TR-TC
Question is: If I decrease the price of steak $1 what
will happen to my revenue?
Math for Measuring Price Elasticity
Problem: Sirloin steak drops $4.00 to
$3.00
Butcher sales increase from 500 lbs to
1,000 lbs
e
Formula: Pe = % Change in Q
% Change in P
500 lbs to 1000 lbs = 500 / 500 = 1 (Q
change = 100%)
$4.00 to $3.00 = 1/ 4 = .25
1 / .25 = 4
The steak at this price is very elastic.
Anything over 1 is elastic.
Helpful Hints
To find coefficient of price elasticity
supply or demand simply:
Find % change in quantity and % change in
price, then divide Q/P
Hint: former-current/former
Price increase $1 to $2, quantity decrease 10 to 8
1/1 x 100 = 100% = P
2/10 x 100 = 20% = Q
20/100 = .2 = inelastic
Bottom Line for Elasticity of Demand
The responsiveness or (sensitivity) of
consumers to a price change is
measured by a product’s price
elasticity of demand
Inelastic demand
perfectly inelastic
totally elastic
Elastic Demand = A small percentage
change in price brings about a large
percentage change in QD
Example: cars, steak, CDs, gold jewelry
Inelastic Demand = Large percentage
change in price brings about a small
percentage change in QD.
Drugs, gasoline, cigarettes, personal
items, deodorant,
Measuring Elasticity
 Elasticity
= (%change in Q)/(%change in P)
If elasticity > 1, demand is elastic.
 If elasticity < 1, demand is inelastic.
 If elasticity = 1, demand is unitary.

All of the inelastic demand concepts depend on
available substitutes
Price of steak goes too high… substitute
chicken
 Price of gasoline too high… no substitute
Income Effect
Income effect simply indicates that at a
lower price one can afford more of the
good without giving up alternative goods.

Determinants of Elasticity

Necessity vs Luxuries ….examples: critical
medicines, addiction, gas to drive, new car, boat,
diamond ring….

Availability of Substitutes…Zirconia, salt
substitute, powdered milk, tea vs coffee…

Proportion of Income…the higher the
price of a good relative to a consumers’ income,
the greater the price elasticity of demand.

Time….As a rule, product demand is more
elastic the longer the time period under
consideration.
Figure 3-2. Demand Curve
Elasticity

Steep demand curves are
inelastic


Small % change in Q in
response to a big change
in P
Shallow (nearly flat)
demand curves are
elastic

Large % change in Q in
response to a small
change in P
P
Steep = inelastic
Dinelastic
Q
P
Shallow =
elastic
Delastic
Q
What does that mean?
If elasticity is greater than 1, demand is
elastic.
Price change causes revenue to change in opposite direction Decrease in price will
increase TR
Inelastic demand is defined as an
elasticity of less than 1 (anything from 0
to .99)
Price changes causes TR to change in same direction. Decrease in price causes
TR to fall
Unit elastic is 1
No change
Price elasticity is 0 because an increase in price will not decrease revenue…nor
will it increase revenue… there is no change in revenue with unit elastic.
How can we calculate coefficient of price
elasticities?
Let’s re-visit our last example
Let’s say that price is increased from $1.00
to $2.00 for a candy bar…..
The quantity demanded decreases from 10
to 8….
How will this producer know if the price
increase brings in more $ relative to
decrease in demand or otherwise????
Percent change in P
1-2=1/1 x 100 = 100% change in P
Percent change in Q
10-8 = 2/10 = 20% change in Q
Response/trigger…..Hence:
E = 20/100 =.2 (% change in Q / % change in P)
Trigger was the price…. Response the quantity
Price moves…(trigger)… quantity change (response)
Because % change is less than 1, candy producer will
not increase revenue by increasing price.
Taxes and Elasticity

Burden of a Tax
 the
product does not pay the tax
 people pay the tax
consumers?
 producers/sellers?

 who
carries the burden of a tax?
Taxes and Elasticity

Inelastic Goods;
 add
a tax
 seller increases P by the amount of the tax
 inelastic response; consumers cut back only a
little
 seller takes the tax out of increased sales
revenues
 buyer carries most of the burden of the tax
Taxes and Elasticity

Elastic Goods;
 add
a tax
 seller increases P by the amount of the tax
 elastic response; consumers cut back by a
large amount
 sales revenue decreases; seller takes the tax
out of profits
 seller carries most of the burden of the tax
THE END!