Transcript Chapter 6

PRINCIPLES OF ECONOMICS
Chapter 6 Consumer Choices
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INVESTMENT IN HUMAN CAPITAL
Higher education is a good investment regardless of
state of the economy.
INVESTMENT IN HUMAN CAPITAL
Those with the highest degrees in 2012 had substantially lower
unemployment rates whereas those with the least formal education
suffered from the highest unemployment rates. The national median
average weekly income was $815, and the nation unemployment
average in 2012 was 6.8%.
THEORY OF CONSUMER BEHAVIOR
The consumer tries to gain the largest possible
benefit from goods and services purchased given
a budget constraint.
Maximize Utility
subject to
Budget Constraint
THEORY OF CONSUMER BEHAVIOR
Budget Constraint: A limit imposed on household
choices by income, wealth, and product prices.
José has income of $56. Movie pickets cost $7 each
and T-shirts cost $14 each. He can buy 8 movie
tickets only, 4 T-shirts only, or any combinations of
both that are affordable like 4 tickets and 2 shirts.
THEORY OF CONSUMER BEHAVIOR
THEORY OF CONSUMER BEHAVIOR
Equation of the budget constraint can be written
PxX + PyY = I
Px = price of X
X = quantity of X
Py = price of Y
Y = quantity of Y
I = consumer income
THEORY OF CONSUMER BEHAVIOR
The budget constraint will rotate out when price of X falls
THEORY OF CONSUMER BEHAVIOR
The budget constraint will shift out in a parallel
manner when consumer income increases.
THEORY OF CONSUMER BEHAVIOR
Total Utility (TU) is the benefit or satisfaction you
receive from consuming a good or service.
Marginal Utility (MU) is the additional satisfaction
gained from consumption an extra unit of a good
or service.
Law of Diminishing Marginal Utility: The more of any
one good consumed, the less satisfaction is received.
MUX declines as you consume more and more X.
THEORY OF CONSUMER BEHAVIOR
Diminishing Marginal Utility
Total Utility and Marginal Utility
Trips
to Club
Total
Utility
Marginal
Utility
1
12
12
2
22
10
3
28
6
4
32
4
5
34
2
6
34
0
THEORY OF CONSUMER BEHAVIOR
The Utility-Maximizing Rule:
In general, utility-maximizing consumers spread out
their expenditures until MU per dollar spent on one
good is equal to MU per dollar spent on any other
good.
MU X MUY
=
PX
PY
MUx: marginal utility of X
MUy: marginal utility of Y
Px: price of X
Py: price of Y
THEORY OF CONSUMER BEHAVIOR
THEORY OF CONSUMER BEHAVIOR
As the price increases from P0 to P1 to P2 to
P3, the budget constraint on the upper part of
the diagram shifts to the left. The utilitymaximizing choice changes from M0 to M1 to
M2 to M3. As a result, the quantity demanded
of housing shifts from Q0 to Q1 to Q2 to Q3,
ceteris paribus.
The Law of Demand: price and quantity
demanded are negatively related. Demand is
downward sloping.
THEORY OF CONSUMER BEHAVIOR
Diminishing Marginal Utility and Downward-Sloping Demand
At price of $40, the utility gained
from even first Thai meal is not
worth the price.
At price of $25, Ann and Tom
eat Thai meals 5 times a month.
At price of $15, Ann and Tom
will eat Thai meals 10 times a
month.
At 25 meals a month, they
cannot tolerate the thought of
another Thai meal even if it is
free.
EC ON OMIC S IN PRACTICE
Substitution and Market Baskets
If we go back to the utilitymaximizing rule that you learned
in this chapter, we see Mr. Smith
comparing the marginal utility of
each product he consumes
relative to its price in deciding
what bundle to buy.
When we restrict Mr. Smith’s
ability to substitute goods, we give
him a more expensive bundle.
THE SUPPLY OF LABOR
Households supply labor and business
firms demand labor. The household
decision to supply labor depends on:
• Availability of jobs
• Market wage rates
• Skills they possess
THE SUPPLY OF LABOR
Households use the wage rates to decide how
much labor to supply and how much leisure to
have.
Substitution Effect: An increase in wage rate will
induce households to supply more labor hours to
make extra income. As wage rate increases, the
quantity supplied of labor will rise.
Income Effect: An increase in wage rate will
induce households to supply fewer labor hours in
order to have more hours of leisure. As wage
rate increases, the quantity supplied of labor will
fall.
THE SUPPLY OF LABOR
The supply of labor in “backward bending” with
substitution effect > income effect at modest wage rates,
but income effect > substitution effect at high wage rates.
THE SUPPLY OF CAPITAL
Households savings supply loanable
funds.
Business firms demand loanable funds.
The supply and demand for loanable finds
determines the rate of interest.
THE SUPPLY OF CAPITAL
Personal savings were about 7 to 11% of personal income
for most of the years from the late 1950s to early 1990s.
Since then, the rate of personal savings has fallen
substantially, although it seems to have bounced back a
bit since 2008.