Consumer Choice  Utility  Consumer surplus  Budget Constraints  Indifference Curves  Utility  Consumer surplus  Budget Constraints  Indifference Curves

I. Utility Analysis  what is utility?  benefit you get from consuming a good  determined by your tastes/preferences (assume these are stable)

total utility (TU)  total benefit from consuming good  example  total benefit from 3 cookies

 TU increases as consumption increases, to a point < TU 2 cookies TU 3 cookies

marginal utility (MU)  change in TU from consuming one more of a good  example  how much MORE utility from an additional pack of gum?

change in TU from 0 to 1 cookie change in TU from 1 cookie to 2 cookies MU of 1 st cookie MU of 2 nd cookie = = 0

diminishing marginal utility  MU falls as consumption rises  get sick of cookies

MU of 1 st cookie > MU of 2 nd cookie 0

TU cookie TU rises at slower and slower rate as MU declines MU cookie

How to maximize TU?  use available budget  equalize MU/$ across goods  Huh?

 chose combination of cookies and milk where price of cookiesprice of milk MU cookies = MU milk

why?  chose combo of 6 cookies, 1 milk  suppose MU/$1 of cookies = 4, MU/$1 of milk = 15  by consuming fewer cookies, more milk … I would add more to my TU

TU vs. MU  Diamond-Water paradox  $10,000  one carat diamond  5 million gallons of tap water

why?  TU of water is greater than TU of diamonds  water is essential for life  BUT water is abundant, diamonds are rarer  MU of last diamond is higher  MU determines value

MU and demand  MU declines as consumption rises  willing to pay less for each additional unit  downward sloping demand

example : pizza P Q D $10 4 pizzas for 4th pizza willing to pay $10 for 2nd pizza $15 2 pizza willing to pay $15

II. Consumer Surplus  difference between what you pay for a good, any what you are WILLING to pay for a good

P Q D $10 my demand curve $12 3 my consumer surplus

P Q D $10 10,000 total consumer surplus area between D and price of pizza

III. The Budget Line  given:  consumer ’ s budget  prices  draw a line representing choices  consumption possibilities

example  2 goods: milk & cookies  bottle of milk = $1  cookie = $.50  daily budget = $4

possible combinations cookies milk

budget line milk cookies

budget line milk cookies Affordable Unaffordable

what if prices change?  changes slope of budget line  suppose cookies = $1

budget line milk cookies cookie = $.50 cookie = $1

what if budget changes  budget line shifts  suppose budget = $5

milk cookies budget = $4 budget = $

IV. Indifference Curves  (appendix)  alternative way to show utility  curve shows combo of goods that deliver same total utility

example: milk and cookies milk cookies Indifference curve Every point on curve has same total utility

TU is higher as curve shifts right milk cookies higher TU lower TU

consumer equilibrium  maximize TU  stay on budget

consumer equilibrium cookies 8 milk best affordable point

consumer equilibrium cookies 8 milk best affordable point

sum it up  consumer decisions based on  preferences  budget constraint  consumer decisions made at the margin  marginal benefit of one more  compared to price of one more