© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/eO’Sullivan/Sheffrin Prepared by: Fernando Quijano and Yvonn Quijano CHAPTERCHAPTER 7 Consumer Choice

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Principle and Individual Demand 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.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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Principle and Individual Demand Individual Demand Curve:Individual Demand Curve: If the price of burgers is $3, Bob consumes 8 burgers per month (point b ). If the price of burgers is $3, Bob consumes 8 burgers per month (point b ). At a price of $2, he consumes 11 burgers per month (point c ). At a price of $2, he consumes 11 burgers per month (point c ).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin 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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Total and Marginal Utility Utility: The satisfaction the consumer experiences when he or she consumes a good.Utility: The satisfaction the consumer experiences when he or she consumes a good. Util: A unit of utility.Util: A unit of utility. Total Utility: The utility (measured in utils) from whatever quantity of the product the consumer gets.Total Utility: The utility (measured in utils) from whatever quantity of the product the consumer gets.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Total and Marginal Utility Marginal utility: The change in total utility from one additional unit of the good.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.Law of diminishing marginal utility: As the consumption of a particular good increases, marginal utility decreases.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Benefit Curve Total and Marginal Utility:Total and Marginal Utility: In panel A, as the quantity of burgers consumed increases, the utility or satisfaction increases at a decreasing rate.In panel A, as the quantity of burgers consumed increases, the utility or satisfaction increases at a decreasing rate.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Benefit Curve Total and Marginal Utility: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 panel B, as the quantity of burgers increases, the marginal utility (the change in utility from one more burger) decreases. Both curves reflect the law of diminishing marginal utility.Both curves reflect the law of diminishing marginal utility.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Cost Curve 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 518 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 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 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 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 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco 35 Marginal Utility of Tacos Number of tacos Marginal benefit (utility) of a taco

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Marginal Cost CurveQuantity Marginal benefit (utils) Marginal cost (utils) 5$18$3 6$16$6 7$14$9 8$12$12Quantity Marginal benefit (utils) Marginal cost (utils) 5$18$3 6$16$6 7$14$9Quantity Marginal benefit (utils) Marginal cost (utils) 5$18$3 6$16$6Quantity Marginal benefit (utils) Marginal cost (utils) 5$18$3Quantity Marginal benefit (utils) Marginal cost (utils) 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.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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin 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.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.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Appendix: Consumer Choice Using Indifference Curves Budget set: A set of points that includes all the combinations of goods that a consumer can afford, given the consumer’s income and the prices of the goods.Budget set: A set of points that includes all the combinations of goods that a consumer can afford, given the consumer’s income and the prices of the goods. Budget line: The line connecting all the combinations of two goods that exhaust a consumer’s budget.Budget line: The line connecting all the combinations of two goods that exhaust a consumer’s budget.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin The Budget Set and Budget Line The budget set (the shaded triangle) shows all the affordable combinations of burgers and tacos.The budget set (the shaded triangle) shows all the affordable combinations of burgers and tacos. The budget line (with endpoints x and y ) shows the combinations that exhaust the budget.The budget line (with endpoints x and y ) shows the combinations that exhaust the budget.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Curves Indifference curve: The set of combinations of goods that generate the same level of utility or satisfaction.Indifference curve: The set of combinations of goods that generate the same level of utility or satisfaction.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Curve and the Marginal Rate of Substitution The indifference curve shows the different combinations of burgers and tacos that generate the same utility level. The indifference curve shows the different combinations of burgers and tacos that generate the same utility level. The slope is the marginal rate of substitution between the two goods (three tacos per burger between points e and f ). The slope is the marginal rate of substitution between the two goods (three tacos per burger between points e and f ).

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Curve and the Marginal Rate of Substitution Superior Combinations:Superior Combinations: All the combinations above the indifference curve generate more satisfaction (higher utility) than combinations on the curve. All the combinations above the indifference curve generate more satisfaction (higher utility) than combinations on the curve. Bob would prefer point h to point e because he gets more of both goods with point h.Bob would prefer point h to point e because he gets more of both goods with point h.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Curve and the Marginal Rate of Substitution Inferior Combinations:Inferior Combinations: All the combinations below the indifference curve generate less satisfaction (lower utility) than combinations on the curve. All the combinations below the indifference curve generate less satisfaction (lower utility) than combinations on the curve. Bob would prefer point e to point g because he gets more of both goods with point e.Bob would prefer point e to point g because he gets more of both goods with point e.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Curve and the Marginal Rate of Substitution Equivalent Combinations:Equivalent Combinations: All combinations along the indifference curve generate the same satisfaction (the same utility) as combination e. All combinations along the indifference curve generate the same satisfaction (the same utility) as combination e. Bob would be indifferent between combinations e and f.Bob would be indifferent between combinations e and f.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Curves Marginal rate of substitution (MRS): The rate at which a consumer is willing to substitute one good for another.Marginal rate of substitution (MRS): The rate at which a consumer is willing to substitute one good for another. There is a negative relationship between burgers and tacos, so the indifference curve is negatively sloped.There is a negative relationship between burgers and tacos, so the indifference curve is negatively sloped.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Indifference Map The indifference map shows a set of indifference curves, with utility increasing as we move northeasterly to higher indifference curves.The indifference map shows a set of indifference curves, with utility increasing as we move northeasterly to higher indifference curves.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Maximizing Utility Consumer Maximizes Utility at Tangency of Indifference Curve and Budget LineConsumer Maximizes Utility at Tangency of Indifference Curve and Budget Line To maximize utility, the consumer finds the combination of hamburgers and tacos at which an indifference curve is tangent to the budget line. To maximize utility, the consumer finds the combination of hamburgers and tacos at which an indifference curve is tangent to the budget line. At the utility-maximizing combination, the marginal rate of substitution equals the price ratio. At the utility-maximizing combination, the marginal rate of substitution equals the price ratio.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Drawing the Demand Curve Consumer’s Response to a Decrease in Price:Consumer’s Response to a Decrease in Price: A decrease in the price of burgers tilts the budget line outward. A decrease in the price of burgers tilts the budget line outward. The indifference curve is tangent to the budget line at a larger quantity of burgers (11 burgers instead of 9). The indifference curve is tangent to the budget line at a larger quantity of burgers (11 burgers instead of 9). This is the law of demand: The higher the price, the smaller the quantity demanded. This is the law of demand: The higher the price, the smaller the quantity demanded.

© 2003 Prentice Hall Business PublishingEconomics: Principles and Tools, 3/e O’Sullivan/Sheffrin Individual Demand Curve At a price of $3 per burger, Bob maximizes his utility with 8 burgers (point e in Figure 7A.5 and point b in Figure 7A.6).At a price of $3 per burger, Bob maximizes his utility with 8 burgers (point e in Figure 7A.5 and point b in Figure 7A.6). At a price of $2 per burger, Bob maximizes his utility with 11 burgers (point n in Figure 7A.5 and point c in Figure 7A.6).At a price of $2 per burger, Bob maximizes his utility with 11 burgers (point n in Figure 7A.5 and point c in Figure 7A.6).