Transcript Document

Chapter 6
Consumer Choice Theory
• Key Concepts
• Summary
• Practice Quiz
• Internet Exercises
©2002 South-Western College Publishing
1
What is util?
A hypothetical unit used
to measure how much
utility a person obtains
from consuming a good
2
What is utility?
The satisfaction, or
pleasure, that people
receive from consuming a
good or service
3
What is total utility?
The amount of satisfaction
received from all the units
of a good or service
consumed
4
Why does a
consumer buy one
bundle of goods,
rather than another?
Consumers make one
choice over another
depending on their
marginal utility
5
What is marginal utility?
The change in total utility
from one additional unit
of a good or service
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What is the law of
diminishing
marginal utility?
The principle that the
extra satisfaction of a
good or service declines
as people consume
more in a given period
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8
6
4
2
Marginal Utility
Diminishing Marginal Utility
MU
1
2
3
4
Q
8
Total Utility
16
TU
12
8
4
1
2
3
4
Q
9
When is total
utility maximized?
When the marginal utility
per dollar of each good
is equal and the entire
budget is spent
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What is
consumer equilibrium?
A condition in which total
utility cannot increase
by spending more of a
given budget on one
good and spending less
on another good
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Even though water
provides a greater utility
than diamonds, why are
diamonds more
expensive?
Water is plentiful in most
of the world, so its
marginal utility is low
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8
6
4
2
Marginal Utility
Marginal Utility of Diamonds
S
MUd
MU
1
2
3
4
Q
13
Marginal Utility of Water
4
2
Marginal Utility
8
6
S
MUw
1
2
MU
3
4
Q
14
Marginal Utility for Big Macs and
Milkshakes (utils per day) ($2 each)
BIG MACS
Quantity
MU MU/P
MILKSHAKES
MU
MU/P
1
8
4
6
3
2
4
2
4
2
3
2
1
1
1/2
4
1
1/2
0
0
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Consumer Equilibrium
=
=
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Consumer Equilibrium
Price of Big Mac = $2
=
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What happens if the
price of a Big Mac
falls to $1 and upsets
the previous
equilibrium?
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Consumer Equilibrium
Price of Big Mac = $1
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What happens to the
number of Big Macs
bought when the
price drops?
To restore maximum
total utility, the
consumer spends more
on Big Macs
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What does this
discussion of
utility reveal?
The law of demand, that
is, as the price of a good
declines, consumers will
buy more units of the
good, and vice versa
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What are two
alternative explanations
of demand?
Income effect
Substitution effect
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What is the
income effect?
The change in
quantity demanded
of a good or service
caused by a change
in real income
(purchasing power)
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What does the income
effect show?
As prices decline, your
real income increases,
increasing your buying
power, so you buy more
units, ceteris paribus
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What is the
substitution effect?
The change in quantity
demanded of a good
or service caused by
the change in its price
relative to substitutes
25
What does the
substitution
effect show?
Suppose the price of a Pepsi
falls and the price of a Coke
remains unchanged; you
will buy more Pepsi,
because relatively, it is less
expensive than Coke
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What does the
substitution and
income effect prove?
The law of demand, that
is, as the price of a
good declines,
consumers will buy
more units of the good,
and vice versa
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What is a normal good?
A good that consumers
will buy more of as
their incomes increase
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What is an
inferior good?
A good that consumers
will buy less of as their
incomes increase
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Key Concepts
30
Key Concepts
•
•
•
•
•
What is util?
What is utility?
What is total utility?
What is marginal utility?
What is the law of diminishing marginal
utility?
• When is total utility maximized?
• What is consumer equilibrium?
31
Key Concepts cont.
• What are two alternative explanations of
demand?
• What is the income effect?
• What is the substitution effect?
• What does the substitution and Income effect
prove?
• What is a normal good?
• What is an inferior good?
32
Summary
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Utility is the satisfaction or
pleasure derived from
consumption of a good or
service. Actual measurement of
utility is impossible, but
economists assume it can be
measured by a fictitious unit
called the util.
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Total utility is the total level of
satisfaction derived from all units
of a good or service consumed.
Marginal utility is the change in
total utility from a one unit
change in the quantity of a good
or service consumed.
35
8
6
4
2
Marginal Utility
Diminishing Marginal Utility
MU
1
2
3
4
Q
36
Total Utility
16
TU
12
8
4
1
2
3
4
Q
37
The law of diminishing
marginal utility states that
marginal utility of a good or
service eventually declines
as consumption increases.
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Consumer equilibrium is the
condition of reaching the
maximum level of satisfaction,
given a budget, when the marginal
utility per dollar spent on each
good purchased is equal.
39
Consumer equilibrium and the law
of diminishing marginal utility can
be used to derive a downwardsloping demand curve. When the
price of a good falls, consumer
equilibrium no longer holds
because the marginal utility the
marginal utility per dollar for the
good rises.
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To restore equilibrium, the
consumer must increase
consumption. As the quantity
demanded increases, the
marginal utility falls until
equilibrium is again achieved.
Thus, the price falls and the
quantity demanded rises, as
predicted by the law of demand
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Consumer Equilibrium
=
=
42
The income effect and the
substitution effect are
complementary explanations for
the law of demand. When the
price changes, these effects
work in combination to change in
the quantity demanded in the
opposite directions.
43
As the price falls, real purchasing
power increases, causing an
increase in the consumer’s
willingness and ability to purchase
a good or service. This is the
income effect. Also, as the price
falls, the consumer substitutes the
cheaper the cheaper good for other
goods that are now relatively more
expensive. This is the substitution
effect.
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If the marginal utility per last
dollar spend on each good is
equal and the entire budget is
spent, total utility is maximized.
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When the price of a normal good
falls, the income effect and the
substitution effect combine to
cause the quantity demanded to
increase.
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END
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