Transcript Chapter 20 - The Citadel

Chapter 20
Consumer
Choice
Introduction
Cyberspace is challenging territory for those
with visual impairments.
Because internet shopping is more difficult for
those with disabilities, economic theory says
that this adds to the cost of internet purchases.
As a result, disabled consumers may buy less
frequently from web-based retailers.
Slide 20-2
Learning Objectives
 Distinguish between total utility
and marginal utility
 Discuss why marginal utility at first
rises but ultimately tends to decline
as a person consumes more of a good
or service
Slide 20-3
Learning Objectives
 Explain why an individual’s optimal
choice of how much to consume of
each good or service entails equalizing
the marginal utility per dollar spent
across all goods and services
 Describe the substitution effect
of a price change on the quantity
demanded of a good or service
Slide 20-4
Learning Objectives
 Understand how the real-income effect
of a price change affects the quantity of
a good or service demanded
 Evaluate why the price of diamonds
is so much higher than the price
of water even though people cannot
survive long without water
Slide 20-5
Chapter Outline





Utility Theory
Graphical Analysis
Diminishing Marginal Utility
Optimizing Consumption Choices
How a Price Change Affects Consumer
Optimum
 The Demand Curve Revisited
Slide 20-6
Did You Know That...
 The pace of product innovation for new
consumer goods is about twice as high
as it was 20 years ago?
 The economic analysis of consumer
choice provides a way to account for
all the variables of taste, income, and
prices as they relate to individual
decisions?
Slide 20-7
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
Slide 20-8
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
Slide 20-9
Total and Marginal Utility
of Watching DVDs
Figure 20-1, Panel (a)
Slide 20-10
Graphical Analysis
Figure 20-1, Panel (b)
Slide 20-11
Graphical Analysis
Figure 20-1, Panel (c)
Slide 20-12
Total and Marginal Utility
of Watching DVDs
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
DVDs Watched per Week
Figure 20-1, Panels (b) and (c)
7
2
3
4
5
6
7
DVDs Watched per Week
…where marginal
utility equals zero.
Slide 20-13
Total and Marginal Utility
of Watching Videos
 Observations
– Marginal utility falls as more is consumed
– Marginal utility equals zero when total
utility is at its maximum
Slide 20-14
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
Slide 20-15
Example: Vending Machines
 How many people take more than
one paper from the vending machine?
 Why not dispense candy the same way?
 The answer is found is the concept of
diminishing marginal utility.
Slide 20-16
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
Slide 20-17
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
DVDs
per
Period
Total Utility
of DVDs per
Period
(utils)
Marginal Utility
(utils)
MUd
Marginal Utility
per Dollar
Spent (MUd/Pd)
(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
Table 20-1
Slide 20-18
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
Pizza Slices
per
Period
Total Utility
of Pizza Slices
per Period
(utils)
Marginal Utility
(utils)
MUp
Marginal Utility
per Dollar
Spent (MUpPp)
(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
Table 20-1
Slide 20-19
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
Table 20-1
Items
per
Period
Marginal Utility
per Dollar
Spent (DVD)
(price = $5)
Marginal Utility
per Dollar
Spent (Pizza)
(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
Slide 20-20
Steps to Consumer Optimum
Choices
DVDs
Pizza Slices
Purchase
Unit
(MUd/Pd)
Unit
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
Table 20-2
(Mup/Pp)
Slide 20-21
Steps to Consumer Optimum
Buying Decision
First DVD
$26 - $5 = $21
Second DVD
$21 - $5 = $16
First pizza slice
$16 - $3 = $13
Third DVD
$13 - $5 = $ 8
Fourth DVD and
second pizza slice
Table 20-2
Remaining Income
$8 - $5 = $ 3
$3 - $3 = $ 0
Slide 20-22
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
Slide 20-23
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
Slide 20-24
How a Price Change
Affects Consumer Optimum
Income = $26
Qd = 4
MUd
36.5
= 7.3
=
Pd
5
Qp = 2
MUp
22
= 7.3
=
Pp
3
Slide 20-25
How a Price Change
Affects Consumer Optimum
Assume Price of DVDs Falls to $4
Qd = 4
MUd
36.5
= 9.13
=
Pd
4
Qp = 2
MUp
22
= 7.3
=
Pp
3
Slide 20-26
How a Price Change
Affects Consumer Optimum
Assume Price of DVDs Falls to $4
Now
Result
MUd
MUp
>
Pd
Pp
Buy more DVDs
and MUd falls
Slide 20-27
Price per Unit ($ per DVD)
DVD Rental Prices
and Marginal Utility
A
5
B
4
D
0
Figure 20-2
1
2
3
DVD Rentals per Week
Slide 20-28
How a Price Change
Affects Consumer Optimum
 The Substitution Effect
– The tendency of people to substitute
cheaper commodities for more expensive
commodities
Slide 20-29
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
Slide 20-30
How a Price Change
Affects Consumer Optimum
 Purchasing Power
– The value of money for buying goods and
services
Slide 20-31
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
Slide 20-32
How a Price Change
Affects Consumer Optimum
 What do you think?
– Which would usually have more of an
impact on your purchases: the
substitution effect or the real-income
effect?
Slide 20-33
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 of the good changes
Slide 20-34
E-Commerce Example:
Virtual 3D Pays Off at Lands’ End
 The retailer Lands’ End provides shoppers
with a 3D simulation of clothing items on a
model with measurements customized to
match those of the shopper.
 Such a feature helps reduce the customer’s
uncertainty.
 Evidence collected so far indicates that
Lands’ End shoppers are willing to pay
higher prices for this feature.
Slide 20-35
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
Slide 20-36
Price (dollars per kilogram)
The Diamond-Water Paradox
Pdiamonds
Pwater
Ddiamonds
Figure 20-3
Quantity per Period
(kilograms)
Dwater
Slide 20-37
Price (dollars per kilogram)
The Diamond-Water Paradox
S2
S1
Pdiamonds
Pwater
Ddiamonds
Qdiamonds
Figure 20-3
Dwater
Qwater
Quantity per Period
(kilograms)
Slide 20-38
International Example:
The World of Water in Saudi Arabia
 Water is five times more expensive
than gasoline in Saudi Arabia.
 Question
– How can we explain this reversal
of the U.S. prices?
Slide 20-39
Issues and Applications:
Internet Shopping with Disabilities
 Web pages are most easily used by
those without visual impairments,
especially because most are not
accompanied by audio files to assist in
navigation.
 If you have difficulty navigating a
website, then any purchase you make
has an added cost.
Slide 20-40
Issues and Applications:
Internet Shopping with Disabilities
 As more websites become better
equipped with voice instructions, they
will be more easily used by those who
cannot navigate the site visually.
 Already, the presence of more aids for
the disabled has contributed to an
increasing volume of internet
commerce.
Slide 20-41
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
Slide 20-42
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
Slide 20-43
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
Slide 20-44
End of
Chapter 20
Consumer
Choice