Consumer Choice

The Individual Demand Curve Individual Demand Curve: The individual demand curve is negatively sloped, consistent with the law of demand: The higher the price, the smaller the quantity demanded. Remember: demand curves always look like this, although the slope may change BUT why does quantity demanded decrease when price increases? what PRINCIPLE is at work? MARGINAL PRINCIPLE

The Law of Demand How can you explain the law of demand using the marginal principle? Discuss with a partner

The Marginal Principle and Individual Demand Individual Demand Curve: If the price of burgers is $3, Bob consumes 8 burgers per month (point b). The law of demand At a price of $2, he consumes 11 burgers per month (point c).

The Marginal Principle and Individual Demand Marginal PRINCIPLE Increase the level of an activity if its marginal benefit exceeds its marginal cost; reduce the level of an activity if its marginal cost exceeds its marginal benefit. If possible, pick the level at which the activity’s marginal benefit equals its marginal cost. We know this can explain the law of supply, because if a firm produces one more product beyond the equilibrium amount it will be losing money What is the marginal benefit to the consumer?

Total and Marginal Utility Utility: The satisfaction the consumer experiences when he or she consumes a good. Util: A unit of utility. Total Utility: The utility (measured in utils) from whatever quantity of the product the consumer gets. The benefit is the utility.

Total and Marginal Utility Marginal utility: The change in total utility from one additional unit of the good. Law of diminishing marginal utility: As the consumption of a particular good increases, marginal utility decreases. Think about hamburgers. If you continue to eat hamburgers once you pass 2 or 3, the satisfaction you get from each additional burger becomes less and less. Eventually eating one or more burgers will make you sick, and utility will be negative.

Utility Can we measure utility? What do you think? Choose a product that you consume on a regular basis and design a system to quantify and measure the utility you receive from it. What would be the pros of quantifying utility? What would be the cons of trying to quantify utility?

The Marginal Benefit Curve Total and Marginal Utility: In panel A, as the quantity of burgers consumed increases, the utility or satisfaction increases at a decreasing rate. The most satisfaction you received was from the first burger, each additional burger resulted in less and less satisfaction After point y, you no longer enjoyed eating the burgers (vomit?)

The Marginal Benefit Curve Total and Marginal Utility: In panel B, as the quantity of burgers increases, the marginal utility (the change in utility from one more burger) decreases. In the first graph, it shows total utility, or how utility adds up with each burger you eat Ie. After eating 8 burgers you receive 152 units of satisfaction. After 14 burgers you receive 182 units of satisfaction. In the second graph we are looking at the amount of utility received after each one unit increase in consumption of the product (i.e. one more burger) i.e. we are not adding up the utility from each burger consumed Both curves reflect the law of diminishing marginal utility.

The Marginal Cost Curve Marginal Utility of Burgers Number of burgers Marginal benefit (utility) of a burger 5 18 6 16 7 14 8 12 Marginal Utility of Burgers Number of burgers Marginal benefit (utility) of a burger 5 18 6 16 7 14 Marginal Utility of Burgers Number of burgers Marginal benefit (utility) of a burger Marginal Utility of Burgers Number of burgers Marginal benefit (utility) of a burger 5 18 6 16 Marginal Utility of Burgers Number of burgers Marginal benefit (utility) of a burger 5 18 6 16 7 14 8 12 9 10 Marginal Utility of Burgers Number of burgers Marginal benefit (utility) of a burger 5 18 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco 3 5 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco 3 5 6 4 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco 3 5 6 4 9 12 2 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco 3 5 6 4 9 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco 3 5 6 4 9 12 2 15 1 If you had only a certain amount of money to spend on food, you could buy burgers or tacos (a taco would be the best alternative to a burger….which principle of economics is this?) If you know how much money you have to spend in total, you can calculate how to receive the maximum amount of utility from combining the perfect amount of burgers and tacos

The Marginal Cost Curve How to draw the marginal cost curve (p.149) Assume your income is $30; a burger is $3, and tacos are $1 each Pick a quantity of burgers = 5 Determine how many tacos you could consume with remaining income $30 – (5 burgers x $3 per burger) = $15 = 15 tacos Use the table to find the marginal utility of one more taco after buying 15 (= 1 util) Calculate the trade-off between burgers and tacos For each burger ($3) you could have bought 3 tacos ($1) Compute the marginal cost of 1 burger If 1 taco = 1 util, then the marginal cost of the 5th burger = 3 utils Plot this point on the marginal cost curve (5, 3) x = # burgers, 3 = # utils In order to determine the right combination of burgers and tacos, we need to satisfy the marginal principle We have to find out where the cost = the benefit, which is difficult because we get a different amount of benefit from tacos and burgers depending on how much we eat Therefore, drawing the marginal benefit curve will be tough!

The Marginal Cost Curve Quantity Marginal benefit (utils) Marginal cost (utils) 5 $18 $3 Quantity Marginal benefit (utils) Marginal cost (utils) Quantity Marginal benefit (utils) Marginal cost (utils) 5 $18 $3 6 $16 $6 Quantity Marginal benefit (utils) Marginal cost (utils) 5 $18 $3 6 $16 $6 7 $14 $9 Quantity Marginal benefit (utils) Marginal cost (utils) 5 $18 $3 6 $16 $6 7 $14 $9 8 $12 Marginal Principle and Demand: The marginal benefit of burgers equals the marginal cost at eight burgers, so the marginal principle is satisfied at point m. You can repeat these steps and find more points on the graph, then draw a line. If you also draw the marginal benefit line for burgers, there is a point where they intersect At this point the marginal principle is satisfied (cost = demand)

Marginal Principle and Demand Remember: You are choosing between 1 burger, or 3 tacos Before 8, each additional burger gives more utility then 3 tacos After 8, each additional burger gives less utility then 3 tacos The 9th burger would give 10 util, while the benefit from 3 tacos would yield 15 util

The Utility-Maximizing Rule Utility-maximizing rule: Pick the affordable combination of consumer goods that makes the marginal utility per dollar spent on one good equal to the marginal utility per dollar spent on a second good. At 8 burgers, you receive a marginal utility of12 utils per dollar spent At 6 tacos, you receive a marginal utility of 4 utils per dollar spent Marginal utility per dollar is like saying how much bang for your buck you can get, how efficiently you are spending your money

The Utility-Maximizing Rule For 8 burgers, and 6 tacos: 12 utils per $ / $3 = 4 utils per $ / $1 4 = 4 Calculate these variables if you chose: 5 burgers and 15 tacos 9 burgers and 3 tacos

The Utility-Maximizing Rule Before the 8 burger point, you receive more marginal utility per dollar for buying burgers vs tacos i.e. more bang for your buck After the 8 burger point, you receive more marginal utility per dollar for buying tacos vs burgers i.e. buying tacos after 8 burgers gives you more satisfaction then buying another burger.

Questions Answer #1-3 “Test Your Understanding” on p. 152 Define the key term on p. 153 in your own words, using an example for each (not discussed in the text or in class) Answer # 1-3 on p. 153-154 Complete Consumer Choice assignment