Transcript d - cloudfront.net

Chapter 6
Consumer Choice and
Demand
© 2006 Thomson/South-Western
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Utility Analysis
Utility: the sense of pleasure, or
satisfaction, that comes from
consumption
Tastes: preferences for different goods
and services  likes and dislikes
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Total and Marginal Utility
 Total utility is the total satisfaction a person
derives from consumption
 Marginal utility is the change in total utility
resulting from a one-unit change in consumption of
a good
 Law of Diminishing Marginal Utility
The more of a good an individual consumes per time
period, other things constant, the smaller the
increase in total utility from additional consumption
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Exhibit 1: Utility Derived from Water
•The first column lists possible
quantities of water a person
might consume after running
on a hot day.
•The second column presents
the total utility derived from
that consumption.
•The third column presents
the marginal utility of each
additional glass of water
consumed  change in total
utility from consuming an
additional unit.
Units of Water
Consumed
Total Marginal
(8 ounce glass) Utility
Utility
0
0
1
40
40
2
60
20
3
70
10
4
75
5
5
73
-2
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Exhibit 2: Total and Marginal Utility
Marginal utility
begins to diminish
with the first unit
Each glass adds
less to total utility
Total utility
increases for the
first four glasses,
but at a decreasing
rate
In a world
without scarcity the
price of water is
zero – a person
would consume 4
glasses of water
Total Utility
Marginal Utility
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Utility Maximization with Scarcity
 Issue here becomes one of maximizing utility
subject to the constraint that your income is
limited and prices are greater than zero
 Suppose that we have the following bits of
information
The price of pizza is $8
The rental price of a movie video is $4
After tax income equals $40 per week
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Exhibit 3: Pizza & Video Rentals
Marginal
Marginal
Utility
Utility
of Pizza
of Videos
Pizza
Total Marginal per Dollar Video
Total Marginal per Dollar
Consumed Utility Utility Expended
Rentals Utility of Utility of Expended
Per Week of Pizza of Pizza (price=$8) per Week Videos Videos
(price=$4)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
0
1
2
0
56
88
56
32
7
4
3
112
24
3
4
5
6
130
142
150
18
12
8
2¼
1½
1
0
1
2
3
4
5
6
0
40
68
88
40
28
20
10
7
5
100
12
3
108
114
8
6
2
1½
You spend your entire budget of $40 on pizza  5 pizzas per week at a total utility of 142
Giving up one pizza frees up enough money to rent two videos, and total utility increases
from 142 to 198
Reducing consumption to three pizzas further increases total utility from 198 units to 212
units  another utility-increasing move
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Utility-Maximizing Condition
Consumer equilibrium is achieved when the
budget is completely spent and the last dollar
spent on each good yields the same utility
MUp MUv

Pv
Pp
Where MUp is the marginal utility of pizza, pp
is the price of pizza, MUv is the marginal utility
of videos, and pv the price of videos
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Law of Demand and Marginal Utility
We now have a single point on the demand
curve for pizzas
At a price of $8, the quantity demanded was 3 pizzas
per week, based on a given income of $40 per week,
a given rental price of $4 per video, and tastes as
reflected in the utility numbers
To generate another point, suppose the price of
pizza declines to $6  Exhibit 4 is the same as
Exhibit 3 except that the price of pizza has been
reduced
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Exhibit 4: Pizza & Video Rentals
Marginal
Marginal
Utility
Utility
Pizza
Total Marginal per Dollar Video
Total Marginal per Dollar
Consumed Utility Utility
Expended Rentals Utility of Utility of Expended
Per Week of Pizza of Pizza (price=$8) per Week Videos Videos
(price=$4)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
0
1
2
3
4
5
6
0
56
88
112
130
142
150
56
32
24
18
12
8
9 1/3
5 1/3
4
3
2
1 1/3
0
1
2
3
4
5
6
0
40
68
88
100
108
114
40
28
20
12
8
6
10
7
5
3
2
1½
Based on the new lower price of pizza we would have $6 unspent. We would
increase our consumption to 4 pizzas per week  total utility increases by the 18
units derived from the 4th pizza. We are once again in equilibrium.
Have another point on the demand curve for pizza, Price = $6, Qd = 4 pizzas
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Exhibit 5: Demand for Pizza Generated from Marginal Utility
a
$8
Price per pizza
The original
position of
consumer
equilibrium is at
point a, where the
consumer
purchased 3 units
of pizza
After the price
declines to $6, the
consumer
purchases 4 units
of pizza, as shown
by point b
b
6
4
2
0
D
1
2
3
4
Pizzas per week
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Exhibit 6: Consumer Surplus
$8
When price = $8, the
marginal utility of other goods
is higher than the marginal
utility of a Subway
If price = $7, consumer is
willing and able to buy one per
month, at $6, two are
purchased; at $5, three are
purchased, and so on
If the market price is $4 –
less than the consumer is
willing to pay – this is a
consumer surplus
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6
5
4
3
2
1
D
0
1
2
3
4
5
6
7
8
Subways per month
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Exhibit 7: Summing Individual Demands to Derive Market Demand
Price
(a) You
(b) Brittany
(d) Market demand
for Subways
(c) Chris
$6
$6
$6
$6
4
4
4
4
2
0
dY
2
0
2 4 6
Subways per month
dB
2 4
2
0
dC
2
dY + dB + dC = D
2
0
2
6
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At a price of $4, you demand 4 Subways, Brittany 2, and Chris none: the market
demand at a price of $4 equals 6
When the price is $2, your quantity demanded is 6, Brittany’s is 4, and Chris’s is 2:
market demand = 12
The market demand shows the total quantity demanded per period by all
consumers at various prices
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Exhibit 8: Market Demand and Consumer Surplus
The market price is $2
All consumers adjust
their quantity demanded
until the marginal
valuation of the last unit
purchased equals $2
However, each consumer
gets to buy all other units
for $2 each
The shaded area depicts
the consumer surplus
when the price is $2
This area shows the
increase in consumer
surplus if the price falls to
$1
$2
D
1
0
Quantity per period
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Consumer Surplus
Consumer surplus is the net benefit consumers
get from market exchange
It can be used to measure economic welfare and
to compare the effects of such concepts as
Different market structures
Different tax structures
Different public expenditure programs
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Role of Time in Demand
Because consumption does not occur
instantaneously, time also plays an important
role in demand analysis
The cost of consumption has two components
The money price of the good
The time price of the good
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Role of Time in Demand
 Other things constant, a good or service that
provides the same benefit in less time is preferred
 The premium for time-saving goods and services
depends on the opportunity cost of a persons time
 Differences in the value of time among consumers
help explain differences in the consumption
patterns observed in the economy
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