Transcript Lecture 6 (Pearson CH 20) – Consumer Choice

Chapter 20
Consumer Choice
Introduction
Once you pay a connection fee to an Internet
service provider you incur no explicit fees
for the cost of your time.
The result may be that people spend
“too much” time surfing the Web. Why?
Chapter Outline
 Utility Theory
 Graphic Analysis
 Diminishing Marginal Utility
 Optimizing Consumption Choices
 How a Price Change Affects Consumer
Optimum
 The Demand Curve Revisited
Did You Know That...
 More than 100 million people in the
U.S. now have access to the Internet?
 What determines how much people
spend on computers, Internet access,
and other family budget items?
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
Utility Theory
 Marginal Utility
– The change in total utility due to
a one-unit change in the quantity
of a good or service consumed
change in total utility
Marginal utility =
change in number of units consumed
Total and Marginal Utility
of Watching Videos
Figure 19-1, Panel (a)
Graphic Analysis
 A graph can be used to display
the values displayed in the table
to better see their relationships.
Total and Marginal Utility
of Watching Videos
Figure 19-1, Panel (b)
Total and Marginal Utility
of Watching Videos
Figure 19-1, Panel (c)
Total and Marginal Utility
of Watching Videos
Total utility is
maximized...
20
10
16
Marginal Utility (utils per week)
Total Utility (utils per week)
18
14
12
10
8
6
4
2
0
8
6
4
2
0
-2
1
-4
1
2
3
4
5
6
Videos Watched per Week
Figure 19-1, Panels (b) and (c)
7
…where marginal
utility equals zero.
2
3
4
5
6
Videos Watched per Week
7
Total and Marginal Utility
of Watching Videos
 Observations
– Marginal utility falls
– Marginal utility = 0 when total utility
is at its maximum
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
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?
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
Total and Marginal Utility from Consuming
Videos and Hamburgers on an Income of $26
Videos
per
Period
Total Utility
of Videos per
Period
(utils)
Marginal Utility
(utils)
MUV
Marginal Utility
per Dollar
Spent (MUV/Pv)
(Price = $5)
0
0.0
——
——
1
50.0
50.0
10.0
2
95.0
45.0
9.0
3
135.0
40.0
8.0
4
171.5
36.5
7.3
5
200.0
28.5
5.7
Total and Marginal Utility from Consuming
Videos and Hamburgers on an Income of $26
Hamburgers
per
Period
Total Utility
of Hamburgers
per Period
(utils)
Marginal Utility
(utils)
MUV
Marginal Utility
per Dollar
Spent (MUV/Pv)
(price = $3)
0
0.0
——
——
1
25
25
8.3
2
47
22
7.3
3
65
18
6.0
4
80
15
5.0
5
89
9
3.0
Total and Marginal Utility from Consuming
Videos and Hamburgers on an Income of $26
Items
per
Period
Marginal Utility
per Dollar
Spent (Video)
(price = $5)
Marginal Utility
per Dollar
Spent (Hamburger)
(price = $3)
0
——
——
1
10.0
8.3
2
9.0
7.3
3
8.0
6.0
4
7.3
5.0
5
5.7
3.0
Steps to Consumer Optimum
Choices
Videos
Purchase
Hamburgers
Unit
(MUV/PV)
Unit
(Muh/Ph)
1
First
10.0
First
8.3
2
Second
9.0
First
8.3
3
Third
8.0
First
8.3
4
Third
8.0
Second
7.3
5
Fourth
7.3
Second
7.3
Steps to Consumer Optimum
Buying Decision
Remaining Income
First video
$26 - $5 = $21
Second video
$21 - $5 = $16
First hamburger
$16 - $3 = $13
Third video
$13 - $5 = $ 8
Fourth video and
second hamburger
$8 - $5 = $ 3
$3 - $3 = $ 0
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
Optimizing Consumption Choices
 A little math
– The rule of equal marginal utilities
per dollar spent
MU of good A
MU of good B
MU of good Z
=
= ... =
price of good A
price of good B
price of good Z
How a Price Change
Affects Consumer Optimum
Income = $26
QV = 4
MUV
36.5
= 7.3
=
PV
5
Qh = 2
MUh
22
= 7.3
=
Ph
3
How a Price Change
Affects Consumer Optimum
Assume Price of Videos Fall to $4
QV = 4
MUV
36.5
= 9.13
=
PV
4
Qh = 2
MUh
22
= 7.3
=
Ph
3
How a Price Change
Affects Consumer Optimum
Assume Price of Videos Fall to $4
Now
Result
MUV
MUh
>
PV
Ph
Buy more videos
and MUV falls
Video Rental Prices
and Marginal Utility
Figure 19-2
How a Price Change
Affects Consumer Optimum
 The Substitution Effect
– The tendency of people to substitute
cheaper commodities for more
expensive commodities
How a Price Change
Affects Consumer Optimum
 The Principle of Substitution
– Consumers and producers shift away
from goods and resources that become
relatively higher priced in favor of goods
and resources that are now lower priced
How a Price Change
Affects Consumer Optimum
 Purchasing Power
– The value of money for buying goods
and services
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
How a Price Change
Affects Consumer Optimum
 What do you think?
– Which would usually have more of an
impact, the substitution or the realincome effect?
The Demand Curve Revisited
 Question
– How is the demand curve derived?
 Answer
– By assuming income, tastes, expectations,
and the price of related goods are not
changing as the price and quantity
demanded of the good changes
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
Price (dollars per kilogram)
The Diamond-Water Paradox
Pdiamonds
Pwater
Ddiamonds
Quantity per Period
(kilograms)
Dwater
Price (dollars per kilogram)
The Diamond-Water Paradox
S1
S2
Pdiamonds
Pwater
Ddiamonds
Qdiamonds
Figure 19-3
Dwater
Qwater
Quantity per Period
(kilograms)
International Example:
The World of Water in Saudi Arabia
 Water is 5 times more expensive
than gasoline.
 Question
– How can we explain this reversal
of the U.S. prices?
Issues and Applications:
Should You Be Charged to Use the Internet?
 A nearly zero price for Internet usage,
after paying the internet service provider
fee leads to Internet congestion.
 The marginal utility per last dollar
spent must be very low.
 The price is not nearly zero because
of the opportunity cost of time.
Web Links
 The following Web link appears in the
margin of this chapter in the textbook:
– http://www.finfacts.ie/Private/win_rst/
w_mar24.htm
Summary Discussion
of 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 of a good
 Law of diminishing marginal utility
– Marginal utility eventually declines
with additional consumption
Summary Discussion
of Learning Objectives
 The substitution effect of a price
change
– A person will substitute among goods
by buying less of a good when its
price increases
 The consumer optimum
– Occurs when the marginal utility per
dollar spent on each good is the same
Summary Discussion
of Learning Objectives
 The real-income effect of a price
change
– A price change affects the purchasing
power of a person’s income
 Why the price of diamonds exceeds
the price of water even though people
cannot long survive without water
– marginal utility determines how much
people are willing to buy
End of Chapter
Chapter 20
Consumer Choice