Transcript EC1110 - Utility & Consumer Choice

SAYRE | MORRIS
Seventh Edition
CHAPTER 5
Consumer Choice
© 2012 McGraw-Hill Ryerson Limited
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CHAPTER 5
Consumer Choice
Learning Objectives:
LO1: Explain the law of diminishing marginal utility
LO2: Derive a consumers’ purchasing rule which ensures
that satisfaction is maximized
LO3: Explain how marginal utility theory is applicable to
real-world examples
LO4: Provide a theoretical rationale for downward sloping
demand curves
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CHAPTER 5
Consumer Choice
Learning Objectives:
LO5: Understand why consumers generally value a product
more than the price they pay
LO6: Understand why some sellers charge different prices to
different consumers for the same product
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LO1
Diminishing Marginal Utility
Marginal
• extra or additional unit
Utility
• the satisfaction or pleasure derived from the
consumption of a product
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LO1
Diminishing Marginal Utility
Marginal Utility
• the amount of additional utility derived from the
consumption of an extra unit of a product
 total utility
Marginal utility (MU) 
quantity
Total Utility
• the sum of the marginal utility from each unit
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LO1
Diminishing Marginal Utility
Marginal Utility applies when:
• the consumer is behaving rationally
• the consumer’s objective is maximum satisfaction
• purchases and consumption take place over a short
period of time
• the units purchased may sometimes be sets of items
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LO1
Diminishing Marginal Utility
TABLE 5.1
Total Marginal Utility
Quantity
Marginal Utility (MU)
Total Utility (TU)
1
45
45
2
36
81
3
25
106
4
21
127
5
12
139
6
0
139
7
-6
133
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LO1
Diminishing Marginal Utility
Law of Diminishing Marginal Utility
• the amount of additional utility decreases as
successive units of a product are consumed
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LO1
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LO1
Self-Test
Complete the table, which shows Michelle’s utility for milkshakes.
Quantity
1
2
3
4
5
6
7
8
Total Utility
(TU)
20
35
_____
_____
58
60
_____
_____
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Marginal Utility
(MU)
_____
_____
10
8
_____
_____
0
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LO1
Self-Test
Complete the table, which shows Michelle’s utility for milkshakes.
Quantity
1
2
3
4
5
6
7
8
Total Utility
(TU)
20
35
45
_____
_____
53
58
60
60
_____
55
_____
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Marginal Utility
(MU)
_____
20
_____
15
10
8
_____
5
2
_____
0
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LO2
Optimal Purchasing Rule
• A rational consumer should purchase the product
that yields the greatest marginal utility per dollar
MU per $ spent 
MU
price
MU A MU B
if

 consume more A
PA
PB
MU A MU B
if

 consume more B
PA
PB
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LO2
Optimal Purchasing Rule
• in order to maximize utility, a consumer should
spend her budget so that $MU spent on all
products is equal
MU A MU B
MU Z

 .......
PA
PB
Pz
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LATTÉS
Quantity
MU
1
2
3
4
5
6
45
36
25
21
12
0
PIECES OF PASTRY
MU per $
(price = $3)
15
12
8.3
7
4
0
Purchase
Product
first
second
third
first pastry
first latté
second
pastry
second
latté
third
pastry
third latté
fourth latté
fourth
fifth
sixth
seventh
LO2
Total spent
Quantity
MU
1
2
3
4
5
6
64
52
40
26
10
0
MU per $
(price = $4)
16
13
10
6.5
2.5
0
$4
7
11
MU
per $ Spent
$16
15
13
Marginal
utility
64
45
52
Total
utility
64
109
161
14
12
36
197
18
10
40
237
21
24
8.3
7
25
21
262
283
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LO2
Self-Test
Given the following marginal utilities and prices, which product
would a rational consumer choose?
Apple
Marginal Utility
Price
Beer
Ice Cream Hot Dog
120
300
140
150
$1.50
$4.00
$2.00
$3.00
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LO2
Self-Test
Given the following marginal utilities and prices, which product
would a rational consumer choose?
Apple
Marginal Utility
Price
Beer
Ice Cream Hot Dog
120
300
140
150
$1.50
$4.00
$2.00
$3.00
A rational consumer would choose an apple because it has the
highest MU per $ as seen here:
MU/Price
Apple Beer Ice Cream Hot Dog
80
75
70
50
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LO3
Marginal Utility Theory
Insights into Consumer Behaviour
• products with low income elasticities (water, food)
have the highest initial marginal utilities, will be
purchased first
• rule applies only to the purchasing of the product,
not to its repeated “consumption”
• cannot compare utilities between people
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LO4
Marginal Utility and Demand
Akio’s Dollar Marginal Utility
Quantity
Consumed
1
2
3
4
5
6
7
Demand Curve, Derived
$MU
Price
$8
5
4
3
2
1
0
$10
9
8
7
6
5
4
3
2
1
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Quantity
Demanded
0
0
1
1
1
2
3
4
5
6
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LO4
Marginal Utility and Demand
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LO4
Diamond Water Paradox
• Why is water (which has a very high value in use)
inexpensive, while diamonds (which have a low
value in use) expensive?
• Value in use is reflected in the total utility of a
product
• Value in exchange (the price) is determined by its
marginal utility.
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LO5
Consumer Surplus
• the difference between what a customer is willing
to pay and the actual price of the product
Drums of
Water
First
Second
Third
Fourth
$MU
$1000
500
200
100
Price
$25
25
25
25
Marginal Consumer Total Consumer
Surplus
Surplus
$975
$975
475
1450
175
1625
75
1700
marginal consumer surplus (MCS)  $MU  price
total consumer surplus4 units  MCS1  MCS2  MCS3  MCS4
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LO5
Consumer Surplus
Consumer surplus = ½ x (32-20) x (60,000-0) = $360,000
OR add up all consumer surpluses
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LO5
Consumer Surplus
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LO5
Self-Test
Assuming partial units cannot be bought, what is the marginal
consumer surplus for each unit bought, and what is the total
consumer surplus if the price is $6?
Price
$10
9
8
7
6
Quantity
1
2
3
4
5
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LO5
Self-Test
Price
$10
9
8
7
6
Qty
1st
2nd
3rd
4th
5th
Quantity
1
2
3
4
5
Willing to pay Actual Price Marginal Surplus
$10
$6
$4
9
6
$3
8
6
$2
7
6
$1
6
6
0
Total consumer surplus = $10
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LO6
Price Discrimination
• the selling of an identical product at a different
price to different customers
• for reasons other than differences in the cost of
production
• consumers have different demands for the same
product
• are therefore prepared to pay different prices
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LO6
Price Discrimination
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LO6
Price Discrimination
To practice price discrimination, must:
• identify groups of customers with different demand
elasticities
• separate them from the others
• ensure that those obtaining the lower prices cannot
resell the product
• ensure that the seller has control over the price
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LO6
Self-Test
Demand for haircuts from seniors differs greatly from that from your
other customers:
Price
20
18
16
14
12
10
8
Qd Seniors
1
4
7
10
13
16
19
Qd Others
9
10
11
12
13
14
15
a) If you could only charge one price to all customers, which price would
give you the greatest sales revenue?
b) Suppose that you charged a different price for seniors. What prices
would you charge each group in order to maximize your sales revenue?
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LO6
Self-Test
Price
20
18
16
14
12
10
8
Qd
Seniors
1
4
7
10
13
16
19
TR
Qd Others
TR
TR Total
$20
72
112
140
156
160
152
9
10
11
12
13
14
15
$180
180
176
168
156
140
120
$200
252
288
308
312
300
282
a) If you could only charge one price to all customers, which price
would give you the greatest sales revenue?
$12, which gives a total sales revenue of $312
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LO6
Self-Test
Price
20
18
16
14
12
10
8
Qd
Seniors
1
4
7
10
13
16
19
TR
Qd Others
TR
TR Total
$20
72
112
140
156
160
152
9
10
11
12
13
14
15
$180
180
176
168
156
140
120
$200
252
288
308
312
300
282
b) Suppose that you charged a different price for seniors. What
prices would you charge each group to maximize your revenue?
$10 to seniors (total revenue of $160). $18 (or $20) to the
other customers (total revenue of $180). (In total, then,
the sales revenue would be $340.)
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Chapter 5 Summary
•
•
•
•
•
Marginal utility and total utility
Consumers’ optimal purchasing rule
The law of diminishing marginal utility and how it
relates to a downward sloping demand curve
Consumer surplus and how to calculate it
Price discrimination and the conditions required
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