Transcript Scarcity and Choice

Chapter 7 –Utility Maximization
I.
The Income Effect
A. A change in price affects consumers’ real income.
B. This change in real income affects the consumer’s
ability to buy all sorts of products, not just the one for
which the price changed.
C. Demand for all normal goods will increase when
the price of any other good goes down (and vice
versa).
D. Demand for inferior goods will increase when the
price of any other good goes up (and vice versa).
Chapter 7 –Utility Maximization
II.
The Substitution Effect
A. A change in price makes a good relatively more
expensive or less expensive than other goods.
B. If price goes up, consumers will switch purchases to
other goods.
C. If price goes down, consumers will switch from
other goods and buy more of the good.
D. The substitution effect and the income effect
combine when prices change to affect consumer
behavior.
E. *Quirky weirdness about inferior goods.
The Law of Diminishing Marginal Utility
I. As a consumer consumes more of a good,
the satisfaction he or she gets from each
additional unit decreases.
II. The more of a good you consume, the less
you will want the next unit.
The Income Effect, the Substitution Effect, and the Law
of Diminishing Marginal Utility all explain why the
demand curve slopes downward.
The Law of Diminishing Marginal Utility
I. Total Utility: the total satisfaction you get from
consuming a specific quantity of a good (e.g. 5
cheeseburgers).
II. Marginal Utility: the amount of satisfaction
you get from consuming one additional unit
(the next cheeseburger).
III. See the graphs on the next slide. This
relationship between total utility and marginal
utility is key for the rest of the course.
The Utility-Maximizing Rule
I. To maximize satisfaction, a consumer should
spend his money so that the last dollar
spent on each good provides the same
amount of marginal utility.
Cal Cool has $250 to spend on cell phones and sunglasses. The table below
presents the utility from cell phones and sunglasses that Cal gets from quantities
of each.
Cell Phones
Sunglasses
Marginal
Marginal
Marginal
Utility
Total Marginal
Utility
Utility
Per $
Quantity Utility
Utility
Per $
Quantity
Total
Utility
0
0
0
0
1
400
1
325
2
700
2
625
3
900
3
825
4
1,000
4
1000
a.
Calculate Cal’s marginal utility for cell phones.
b.
Calculate Cal’s marginal utility for sunglasses.
Cal Cool has $250 to spend on cell phones and sunglasses. The table below
presents the utility from cell phones and sunglasses that Cal gets from quantities
of each.
Cell Phones
Sunglasses
Marginal
Marginal
Marginal
Utility
Total Marginal
Utility
Utility
Per $
Quantity Utility
Utility
Per $
Quantity
Total
Utility
0
0
0
1
400
2
0
0
0
0
400
1
325
325
700
300
2
625
300
3
900
200
3
825
200
4
1,000
100
4
1000
175
a.
Calculate Cal’s marginal utility for cell phones.
b.
Calculate Cal’s marginal utility for sunglasses.
0
Cal Cool has $250 to spend on cell phones and sunglasses. The table below
presents the utility from cell phones and sunglasses that Cal gets from quantities
of each.
Cell Phones
c.
Sunglasses
Marginal
Marginal
Marginal
Utility
Total Marginal
Utility
Utility
Per $
Quantity Utility
Utility
Per $
Quantity
Total
Utility
0
0
0
0
0
0
0
0
1
400
400
4
1
325
325
6.5
2
700
300
3
2
625
300
6
3
900
200
2
3
825
200
4
4
1,000
100
1
4
1000
175
3.5
The price of cell phones is $100 and a pair of sunglasses is $50.
Determine the consumption bundle of cell phones and sunglasses
that maximizes Cal’s utility.
Cal Cool has $250 to spend on cell phones and sunglasses. The table below
presents the utility from cell phones and sunglasses that Cal gets from quantities
of each.
Cell Phones
c.
Sunglasses
Marginal
Marginal
Utility
Utility
Per $
Quantity
Marginal
Marginal
Utility
Utility
Per $
Quantity
Total
Utility
0
0
0
0
0
0
0
0
1
400
400
4
1
325
325
6.5
2
700
300
3
2
625
300
6
3
900
200
2
3
825
200
4
4
1,000
100
1
4
1000
175
3.5
Total
Utility
The price of cell phones is $100 and a pair of sunglasses is $50.
Determine the consumption bundle of cell phones and sunglasses
that maximizes Cal’s utility.
Snacks (Price = $4)
Quantity
Total
Utility
1
2
3
4
5
15
25
31
34
36
Drinks (Price = $2)
Marginal
Marginal Utility
Quantity
Utility
per
Dollar
1
2
3
4
5
6
7
8
$20 to spend.
Total
Utility
12
21
29
36
42
47
50
52
Marginal
Marginal Utility
Utility
per
Dollar
Snacks (Price = $4)
Quantity
Total
Utility
1
2
3
4
5
15
25
31
34
36
Drinks (Price = $2)
Marginal
Marginal Utility
Quantity
Utility
per
Dollar
15
10
6
3
2
1
2
3
4
5
6
7
8
$20 to spend.
Total
Utility
12
21
29
36
42
47
50
52
Marginal
Marginal Utility
Utility
per
Dollar
12
9
8
7
6
5
3
2
Snacks (Price = $4)
Quantity
Total
Utility
1
2
3
4
5
15
25
31
34
36
Drinks (Price = $2)
Marginal
Marginal Utility
Quantity
Utility
per
Dollar
15
10
6
3
2
3.75
2.5
1.5
.75
.5
1
2
3
4
5
6
7
8
$20 to spend.
Total
Utility
12
21
29
36
42
47
50
52
Marginal
Marginal Utility
Utility
per
Dollar
12
9
8
7
6
5
3
2
6
4.5
4
3.5
3
2.5
1.5
1
Snacks (Price = $4)
Quantity
Total
Utility
1
2
3
4
5
15
25
31
34
36
Drinks (Price = $2)
Marginal
Marginal Utility
Quantity
Utility
per
Dollar
15
10
6
3
2
3.75
2.5
1.5
.75
.5
1
2
3
4
5
6
7
8
$20 to spend.
Total
Utility
12
21
29
36
42
47
50
52
Marginal
Marginal Utility
Utility
per
Dollar
12
9
8
7
6
5
3
2
6
4.5
4
3.5
3
2.5
1.5
1
Quantity of Chicken
Wings
Marginal Utility of
Chicken Wings
Units of Doughnuts
Marginal Utility of
Doughnuts
1
2
3
4
5
6
7
8
10
9
8
7
6
5
4.5
4
1
2
3
4
5
6
7
8
4
3.5
3
2.5
2
1.5
1
.5
Chicken Wings cost $2
Doughnuts cost $1
$10 to spend.
5
4.5
4
3.5
3
2.5
2.25
2
Marginal Utility per Dollar
4
3.5
3
2.5
2
1.5
1
.5
Quantity of Chicken
Wings
Marginal Utility of
Chicken Wings
Quantity of
Doughnuts
Marginal Utility of
Doughnuts
1
2
3
4
5
6
7
8
10
9
8
7
6
5
4.5
4
1
2
3
4
5
6
7
8
4
3.5
3
2.5
2
1.5
1
.5
Chicken Wings cost $2
Doughnuts cost $1
$10 to spend.
Homework
• Read Chapter 7
• Do Problems 1, 2, 3, & 5.
Excise Taxes
Here’s what you need to know:
1. What will the new equilibrium price and quantity
be?
2. How much of the tax will consumers and producers
each pay?
3. What will be the price buyers are actually paying?
4. What will be the price sellers are actually getting?
5. How much tax revenue will be collected?
6. How much will deadweight loss be?
7. What happens to consumer and producer surplus?
What’s Left – your questions?