6 Consumer Choice and Demand SLIDES CREATED BY ERIC CHIANG ALTRENDO IMAGES/GETTY IMAGES CHAPTER 6 SLIDE 1

CHAPTER OBJECTIVES Use a budget line to determine the constraints on consumer choices. Determine how budget lines change when prices or income changes. Describe the difference between total and marginal utility. Explain the law of diminishing marginal utility.  CHAPTER 6 SLIDE 2

CHAPTER OBJECTIVES Define the utility maximization rule and explain how it optimizes consumption given a budget. Equate the marginal utility per dollar between two or more goods. Explain why individuals sometimes make irrational decisions in predictable ways. Describe five psychological factors that influence economic decision making. CHAPTER 6 SLIDE 3

BUDGET LINE ROBERT HARDING WORLD IMAGERY/CORBIS ILLUSTRATES THE COMBINATIONS OF TWO GOODS THAT CAN BE PURCHASED WITH A GIVEN INCOME AND THE PRICES OF EACH GOOD. CHAPTER 6 SLIDE 4

THE BUDGET LINE Weekly budget (income) = $50 Prices: pizza = $10 6 d 5 Prices: pizza = $10 climbing = $20/hour From c to b, one gives up 2 pizzas for 1 hour of climbing 4 PIZZAS (NUMBER OF) c 3 One can consume 5 pizzas, 2.5 hours of climbing, or some combination. 2 b 1 a 1 2 3 4 5 6 WALL CLIMBING (HOURS) CHAPTER 6 SLIDE 5

BUDGET LINE: CHANGE IN PRICE The price of wall climbing falls to $10 per hour, and the price of pizza does not change. 6 d 5 The budget line pivots outward, making many more combinations affordable. 4 PIZZAS (NUMBER OF) c 3 2 b 1 a 1 2 3 4 5 6 WALL CLIMBING (HOURS) CHAPTER 6 SLIDE 6

BUDGET LINE: CHANGE IN PRICE The price of wall climbing stays at $10 per hour, and the price of pizza increases to $12.50. 6 5 The budget line pivots inward, reducing consumption choices. 4 PIZZAS (NUMBER OF) 3 2 1 1 2 3 4 5 6 WALL CLIMBING (HOURS) CHAPTER 6 SLIDE 7

BUDGET LINE: INCOME CHANGES Using the original prices ($10 for pizza and $20 for climbing), suppose income rises to $60. 6 5 The budget line shifts parallel outward, allowing more consumption choices. A reduction in income would shift the line inward. 4 PIZZAS (NUMBER OF) 3 2 1 1 2 3 4 5 6 WALL CLIMBING (HOURS) CHAPTER 6 SLIDE 8

UTILITY ERIC CHIANG A HYPOTHETICAL MEASURE OF THE SATISFACTION ONE RECEIVES FROM CONSUMING A GOOD OR SERVICE CHAPTER 6 SLIDE 9

TOTAL VERSUS MARGINAL UTILITY TOTAL UTILITY MARGINAL UTILITY THE ADDITIONAL SATISFACTION FROM CONSUMING ONE MORE UNIT OF A GOOD OR SERVICE THE TOTAL SATISFACTION FROM CONSUMING A GIVEN QUANTITY OF A GOOD OR SERVICE CHAPTER 6 SLIDE 10

MARGINAL UTILITY ANALYSIS Studies consumer decision making in the face of budget constraints Asserts that rational consumers will allocate their incomes to maximize their own well-being Determines at which point on the budget line one consumes to maximize utility CHAPTER 6 SLIDE 11

LAW OF DIMINISHING MARGINAL UTILITY ERIC CHIANG AS ONE CONSUMES MORE OF A GIVEN PRODUCT, THE ADDITIONAL SATISFACTION FROM EACH ADDITIONAL UNIT FALLS. CHAPTER 6 SLIDE 12

TOTAL AND MARGINAL UTILITY 300 250 TU Total utility rises at a decreasing rate, then falls. 200 TOTAL UTILITY 150 100 50 1 2 3 4 5 6 Marginal utility falls because of diminishing returns and can become negative. 120 100 80 MARGINAL UTILITY 60 40 20 MU 1 2 3 4 5 6 QUANTITY CHAPTER 6 SLIDE 13

UTILITY MAXIMIZATION RULE INDIVIDUALS MAXIMIZE TOTAL SATISFACTION WHEN CONSUMING WHERE THE MARGINAL UTILITY PER DOLLAR IS EQUAL FOR ALL GOODS AND SERVICES. FOR GOODS a, b, … n: CHAPTER 6 SLIDE 14

DERIVING DEMAND CURVES How will consumers react if the price of a good falls? A price change alters the optimal combination of goods purchased. It is also reflected as a movement along the demand curve. CHAPTER 6 SLIDE 15

DERIVING DEMAND CURVES 5 Suppose the price of climbing increases from $20/hour to $30/hour. 4 3 PIZZAS (NUMBER OF) b a 2 1 1 2 3 The change in price is reflected as a movement up the demand curve. 40 b 30 PRICE (PER HOUR) a 20 10 D 1 2 3 WALL CLIMBING (HOURS) CHAPTER 6 SLIDE 16

LIMITATIONS OF MARGINAL UTILITY THEORY Can consumers really measure the utility they receive from various goods? Do consumers calculate the marginal utility associated with each activity? CHAPTER 6 SLIDE 17

JEREMY BENTHAM (1748–1832) Philosopher who argued that human action results from a type of cost-benefit analysis. Main contribution: People make decisions based on the marginal utility they hope to derive. CHAPTER 6 SLIDE 18

BEHAVIORAL ECONOMICS THE STUDY OF HOW HUMAN PSYCHOLOGY ENTERS INTO ECONOMIC BEHAVIOR AS A WAY TO EXPLAIN WHY INDIVIDUALS SOMETIMES ACT IN PREDICTABLE WAYS COUNTER TO ECONOMIC MODELS. CHAPTER 6 SLIDE 19

FIVE PSYCHOLOGICAL FACTORS INFLUENCING ECONOMIC BEHAVIOR IMAGE SOURCE/CORBIS SUNK COST FALLACY FRAMING BIAS OVERCONFIDENCE OVERVALUING THE PRESENT RELATIVE TO FUTURE ALTRIUSM CHAPTER 6 SLIDE 20

RANDY FARIS/CORBIS SUNK COST FALLACY: DECISIONS ARE INFLUENCED BY COSTS ALREADY INCURRED INSTEAD OF HOW THE DECISION AFFECTS CURRENT WELL-BEING. EXAMPLE: REFUSING TO DROP A CLASS BECAUSE TUITION IS ALREADY PAID. CHAPTER 6 SLIDE 21

FRAMING BIAS TECHNIQUES USED TO STEER INDIVIDUALS TO MAKING ONE DECISION OVER ANOTHER. buy one, get one 50% off VS. 25% off purchase gas price VS. gas price $2.999 $3.00 per per gallon gallon CHAPTER 6 SLIDE 22

ARND ROCKSER/DREAMSTIME.COM OVERCONFIDENCE. EXAMPLE: MANY GYM MEMBERSHIPS GO UNUSED BECAUSE AMBITION EXCEEDS FOLLOW-THROUGH. CHAPTER 6 SLIDE 23

OVERVALUING THE PRESENT RELATIVE TO FUTURE OVERVALUING THE PRESENT RELATIVE TO FUTURE. EXAMPLE: NOT SAVING ENOUGH FOR RETIREMENT. CAMMERAYDAVE/DREAMSTIME.COM CHAPTER 6 SLIDE 24

JACOBS STOCK PHOTOGRAPHY/EXACTOSTOCK/SUPERSTOCK ALTRUISM. EXAMPLE: WHY DO PEOPLE LEAVE GENEROUS TIPS IF IT DOES NOT AFFECT THE QUALITY OF SERVICE ALREADY PROVIDED? CHAPTER 6 SLIDE 25

KEY CONCEPTS Budget line Marginal utility analysis Utility Total utility Marginal utility Law of diminishing marginal utility Utility-maximizing rule Behavioral economics Sunk cost Sunk cost fallacy Framing bias Altruism KEY CONCEPTS CHAPTER 6 SLIDE 26

ACCORDING TO MARGINAL UTILITY THEORY, CONSUMERS MAXIMIZE SATISFACTION WHEN THEY: CAN GET MUCH MORE OF ONE GOOD THAN ANOTHER. A CAN GET CREDIT AND SPEND MORE THAN INCOME. B ARE COMPLETELY SATISFIED WITH EVERY GOOD CONSUMED. C Answer: D EQUALIZE MARGINAL UTILITY PER DOLLAR FOR ALL GOODS. D SPEND ALL OF THEIR MONEY, LEAVING NOTHING OVER. E CHAPTER 6 SLIDE 27

RITA JAYARAMAN/DREAMSTIME.COM PRACTICE QUESTION Answer: One should consume sushi, because it achieves 3.125 utils per dollar, while sashimi only provides 2.5 utils per dollar. A SUSHI ROLL COSTS $8 AND GIVES 25 UTILS; SASHIMI COSTS $4 AND GIVES 10 UTILS. WHICH ITEM SHOULD ONE CONSUME NEXT? CHAPTER 6 SLIDE 28

THE PRINCIPLE OF DIMINISHING MARGINAL UTILITY CAN BE USED TO EXPLAIN: WHY TODD’S SECOND SODA IS LESS ENJOYABLE THAN HIS FIRST. A WHY TODD’S FIRST SODA IS LESS ENJOYABLE THAN HIS SECOND. B WHY AMY’S THIRD SODA IS LESS ENJOYABLE THAN TODD’S FIRST. C Answer: A WHY AMY’S THIRD SODA IS AS ENJOYABLE AS TODD’S FIRST. D WHY AMY ENJOYS HER FIRST SODA MORE THAN TODD DOES. E CHAPTER 6 SLIDE 29

PTOONE/DREAMSTIME.COM PRACTICE QUESTION Answer: It is related to two factors: Sunk cost fallacy and overconfidence. WHAT BEHAVIORAL FACTOR(S) EXPLAIN(S) WHY INVESTORS ARE OFTEN RELUCTANT TO SELL ASSETS AT A LOSS? CHAPTER 6 SLIDE 30

WHICH OF THE FOLLOWING IS A MAJOR CRITIQUE OF MARGINAL UTILITY THEORY? IT CANNOT EXPLAIN HOW CONSUMERS MAKE CHOICES. A IT HAS BEEN REFUTED BY BEHAVIORAL ECONOMISTS. B IT CANNOT BE USED TO DERIVE CONSUMER DEMAND CURVES. C Answer: E IT APPLIES ONLY TO GOODS, NOT TO SERVICES. D IT IS DIFFICULT TO MEASURE THE UTILITY OF GOODS CONSUMED. E CHAPTER 6 SLIDE 31

6 END OF CHAPTER SLIDES CREATED BY ERIC CHIANG CHAPTER 6 SLIDE 32 Tshooter/Shutterstock; Anton Balazh/Shutterstock CHAPTER 6 SLIDE 32