Chapter 6 Professor Yuna Chen 1 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Consumer Choice and Demand

2 6-1 Utility Analysis Utility –Sense of pleasure –satisfaction that comes from consumption –Subjective Assumption –Taste are given –Tastes are relatively stable © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-1a Taste and Preference Total utility –Total satisfaction you derive from consumption Of consuming a particular good from all consumption Marginal utility –Change in total utility from one-unit change in consumption 3 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Classroom Experiment Question: What is your dream car? Knock, knock… … 4 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-1b Law of Diminishing Marginal Utility Law of diminishing marginal utility –The more of a good consumed The smaller the increase in total utility Other things constant Marginal utility from each additional unit –Declines as more is consumed Total utility increases as long as marginal utility is positive 5 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-2 Measuring Utility 6-2a Units of utility –abstract concept rather than a concrete, observable quantity. –The "amount" of utility, therefore, are arbitrary, representing a relative value –Each person has a uniquely subjective utility scale 6 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-2b Utility Maximization without Scarcity Goods are free if they are not scarce –Increase consumption as long as marginal utility is positive Two free goods –Increase consumption of each good until the marginal utility of each is 0 7 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Question Cookies and drinks were offered in a party. Valerie went to the party with her marginal utility of the first cookie being 50, the 2 nd one being 10, and the third being 0. For the drinks, her marginal utility of the first cup is 20, the 2 nd is 5, the 3 rd is -10. How many cookies and drinks did Valerie consume? Answer: Valerie must have eaten 2 cookies, and drank two cups of drinks. 8 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Case 1 Utility Maximization with Scarcity Goods are not free (price of movie = $6, price of cookie = $3) Income – limited (Income = $30) How to maximize total utility? 9 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Table 1. TU and MU MoviesCookies QTUMUQTUMU © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Table 2 ChoicesMovieCookieTU A = 291 B1 C2 D3 E4 F5 11 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Choice _____ maximizes utility Consumer equilibrium - There is no way to increase utility by reallocating the budget Any change to other choices will reduce utility

Case 1 Case 1. Find MU per $ spent 12 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. MoviesCookie QMUMUm/PmQMUMuc/Pc

6-2d Utility-Maximizing Conditions Utility-maximizing condition: –Last $ spent on each good yields the same marginal utility 13 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. There is a typo in the formula in textbook page 90.

6-2d Utility-Maximizing Conditions In terms of utility theory, “equilibrium” in the real world means that households have spent their incomes in such a way that their overall satisfaction is maximized. 14 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-2e MU and the Law of Demand Recall Case 1. Income = $30, Pm = $6, To max utility: Qm = 2 (Locate this in a diagram) Case 2. Income = $30, Pm = $3 Find the utility max Qm Qm = 5 (Locate this in a diagram) 15 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Example 16 Demand for Movie Generated From Marginal Utility 3 $6 Price of movie Movie 5 20 D a b © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Relationship between a demand curve and utility maximization:

Surprise!!! Demand curve is a result of utility maximization! 17 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Question Suppose the price of a chocolate bar is $2 and the price of a pack of chocolate chip cookies is $5. Assuming the consumer is at equilibrium, and the marginal utility of chocolate bar is 6, what is the marginal utility of chocolate chip cookies? Pb = $2 Pc = $5 MUb = 6 Muc = ? 18 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Answer 19 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-3a Consumer Surplus Consumer surplus –The difference between what a consumer is willing and able to pay and what the consumer actually pays 20 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Example Example: I am willing and able to pay $10 for a movie ticket. At the theater, the ticket costs me $6. What is my consumer surplus? CS = $10 - $6 = $4 Question. I am willing and able to pay $2 for a chocolate bar. The store is selling it at $4. What is my consumer surplus? -Will not buy it -CS = 0 -CS can’t be negative 21 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

6-3b Market Demand &Consumer Surplus Consumer surplus for the market –Amount consumers are willing to pay minus amount they pay –Net benefit for consumers –Economic welfare 22 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Example 2. How to calculate CS? If the market price is $10, how much is CS? 23 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. $10 $30 Price Books D

Question. What happen to consumer surplus if price falls? Consumer surplus increases. 24 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.