1. Economics 10 1 2017 September Lecture 5 Chapter 8 Consumer Choice
2017 Economics 101 CCC

2. content Consumer Choice Budget Line
Preferences - Utility , Max, Total, Diminishing
Marginal utility theory of consumer choice
Utility Max Choices
Prediction using marginal utility theory
price and income changes Rise in income, good , alternative good
paradox of value
New ways of explaining consumer choices

3. Consumer Choice, Consumption Possibilities and Demand

4. Consumer choice
Economics ideas
Model?
Law?
Goal?

5. Consumer choice and Demand
If you demand something, then you
1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
quantity demanded is ?

6. Consumers choice & Demand & Type of Goods
Normal Goods
Inferior Goods
Substitutes
Complements
What happens to Qd when prices of these increase?
What happens to Qd when prices of these decrease?

7. Consumption Choices
Utility Max Choices of consumers influenced by two factors
Consumption Possibilities ( Budget)
What consumers can afford
Consumer Preferences (Utility)
Description of Likes and Dislikes
Brings in utility and marginal utility
Lets go to a model ..

8. Consumption Choices
1. Consumption Possibilities defined via Budget Line
Defines boundary between those combinations of goods and services consumer can and cannot afford
Budget constrains choices:
Points on the budget line and inside the budget line are
Points beyond the budget line are not affordable
The line shows all possibilities for the consumer

9. Consumption Choices
1. Consumption Possibilities defined via Budget Line
Consumer’s Budget Line and thus Consumption Possibilities Changes when income or prices change.
increase in income - rightward shift without changing its slope.
change in the price of one of the goods - intercept on its axis and thus slope of the budget line changes.
Changes to the line changes possibilities

10. Consumption Choices
OK – now you know possibilities but how do you decide on what combo?
How many Pizza and how many books?

11. Consumption Choices
2. Consumer’s Preference
The choice a consumer makes depends on preferences and the need to max utility
Decided using marginal utility

12. Consumption Choices 2. Consumer’s Preference
Utility, Choices - rational people – decision making
Economist use the concepts of
Utility – the satisfaction or happiness or benefit people derive from consuming goods and services.
Utility Maximization – goal, assume people try to allocate their income to maximize their satisfaction
Total Utility (TU)- utility people derive from all their consumption activities.
Marginal utility (MU)- The additional utility gained from consuming an additional unit of a good (or service)

13. Consumption Choices 2. Consumer’s Preference
Utility – ? Where do we get these numbers?
Pizza – one slice 25 units of utility then……

14. Consider the hamburger example first hamburger - taste great…

15. Consumption Choices So we experience Diminishing Marginal Utility
As the consumption of a good increases
additional utility gained from an extra unit of the commodity tends to decline
E.g. the second hamburger eaten gives more utility than the 6th hamburger eaten

16. Consumption Choices Given Consumption Possibilities (Budget)
Consumer Preferences (Utility )
consumers make Utility-Maximizing Choice
And Consumer Equilibrium & Optimal Consumption results
consumer has allocated all available income in a way that maximizes utility given the prices of the products.

17. As Lisa sees more movies in a month, her total utility from movies increases.
As the number of movies seen in a month increases, marginal utility from movies decreases.

18. Graph it ..total utility

19. Graph it ..marginal utility

20. Utility-Maximizing Choice: Two methods
Spreadsheet solution
Choose at the margin

21. Utility-Maximizing Choice
Option 1: Spreadsheet Solution
Decision - select combo of goods with max total utility
Define utility ..goods .. Excel etc.

22. Utility-Maximizing Choice
Option 1: Spreadsheet Solution
Consumer Equilibrium
Choose combination that gives highest total utility.
90 units of utility from the 2 movies and 225 units of utility from the 6 cases of pop.

23. Utility-Maximizing Choice
Option 2: Choosing at the Margin
Decision is .. Would spending a dollar more or a dollar less on a good bring more total utility?
Consumer Equilibrium - consumer spends all available income and equalizes marginal utility per dollar for all goods.
MUM/PM and MUP/PP ,
Called the Rational Spending Rule

24. Utility-Maximizing Choice
Option 2: Choosing at the Margin
Not Consumer Equil: If the consumer is left with money to spend, opportunities for increasing utility are left unused, not a utility max choice to do this.
Two conditions need to be met when a consumer is maximizing utility
Spend all income
MU/dollar per good is same
Or else you cold do better and get more total utility!
So then -What do you do ?Apply the rule!

25. In row B,
MUP/PP < MUM/PM.
Lisa spends too much on pop and too little on movies.
If Lisa spends less on pop and more on movies, …
MUP increases and MUM decreases.

26. In row D,
MUP/PP > MUM/PM.
Lisa spends too much on movies and too little on pop.
If Lisa spends less on movies and more on pop, …
MUM increases and MUP decreases.

27. In row C,
MUP/PP = MUM/PM.
Lisa maximizes her total utility.

28. Utility maximizing Choice
When marginal utility per dollar differs between goods, consumption can be rearranged by cutting back on the good with the low marginal utility per dollar and spending the dollar on the good with the high marginal utility per dollar and increasing total utility.

29. Utility maximizing Choice
Why don’t consumers simply choose the goods with the highest marginal utility?
Consider: two goods - new shirt and a new download of a song.
new shirt - marginal utility of 20 and $30
download marginal utility of 1 and $1
Go with the new shirt because it has a higher marginal utility?
Need to focus on marginal utility per dollar (download 1 as opposed to shirt 2/3).

30. Revealing Preference?

31. Using MU Theory to predict

32. Predictions of Marginal Utility Theory
1. A Fall in the Price of a Movie
When the price of a good falls the quantity demanded of that good increases—the demand curve slopes downward.
To restore consumer equilibrium (maximum total utility) apply the Rational Spending rule:
More Movies
Less Pop
Two market effect!
restore MUM/PM = MUP/PP.
.. A change in the price of one good changes the demand for another good.

33. Predictions of Marginal Utility Theory
Graphically
A Fall in the Price of a Movie
increases the quantity of movies demanded—a movement along the demand curve for movies, …
decreases the demand for pop—a shift of the demand curve for pop.
Two market effect

34. Predictions of Marginal Utility Theory
2, A Rise in the Price of Pop
To restore consumer equilibrium (maximum total utility) apply the Rational Spending rule:
Pop decreases
Movies increase
restore MUM/PM = MUP/PP.

35. Predictions of Marginal Utility Theory
A Rise in the Price of Pop
Graphically
rise in the price of pop decreases the quantity of pop demanded—a movement along the demand curve for pop.
Two market effect

36. Predictions of Marginal Utility Theory
A Rise in Income
demand for a normal good increases.
Income increases - more movies and more pop.

37. Paradox of value

38. MU helps to explain prices of goods in the market
Paradox of Value
“water essential to life but price is cheap relative to diamonds which are not essential. Use total utility and marginal utility to assess:
we have
so much water that its marginal utility is small.
so few diamonds that its marginal utility is high.
When a household maximizes its utility, it makes the marginal utility per dollar equal for all goods.
Because diamonds have a high marginal utility, they have a high price.
Because water has a low marginal utility, it has a low price.
MU helps to explain prices of goods in the market

39. New ways to review consumer preferences

40. New Ways of Explaining Consumer Choices
1 Behavioural Economics
Behavioural economics studies the ways in which limits on the human brain’s ability to compute and implement rational decisions influences economic behaviour—both the decisions that people make and the consequences of those decisions for the way markets work.
There are three impediments to rational choice:
Bounded rationality
Bounded willpower
Bounded self-interest

41. New Ways of Explaining Consumer Choices
Behavioural Economics
Bounded rationality
rationality that is bounded by the computing power of the human brain.
Faced with uncertainty, consumers cannot rationally make choices and instead rely on other decision-making methods such as rules of thumb, listening to the views of others, or gut instinct.

42. New Ways of Explaining Consumer Choices
Behavioural Economics
Bounded will-power
less-than-perfect willpower that prevents us from making a decision that we know, at the time of implementing the decision, we will later regret.
Bounded Self-Interest
limited self-interest that sometimes results in suppressing our own interests to help others.
Main applications are in finance where uncertainty is the key factor and savings where future is the key factor.

43. New Ways of Explaining Consumer Choices
Behavioural Economics
The Endowment Effect
tendency for people to value something more highly simply because they own it.

44. New Ways of Explaining Consumer Choices
Neuroeconomics
Study of the activity of the human brain when a person makes an economic decision.
System 1 and System 2

45. New Ways of Explaining Consumer Choices
1 & 2 methods are Controversial
Controversy
Should economics focus on explaining the decisions we observe or should it focus on what goes on inside people’s heads?
This is the controversy.
For most economists, the goal of economics is to explain the decisions that we observe people make, and not to explain what goes on inside people’s heads.

46. Consumer Choice and Government Role

47. Consumer Choice and Government Role
Better choices for consumers!
According to 2014 data from the N.W.T. Bureau of Statistics, 32.2 per cent of adults over the age of 18 qualify as obese.
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48. Questions How do consumers make choices?
What influences the preferences? Budget line?
How is consumer choice linked to demand schedules?
Would people voluntarily pay for something seemingly undesirable?
How exactly does the rational spending rule work?
How does price or income change influence choice? consumption? Graph it!
The marginal utility curve for a “necessity” is vertical line Why? Explain. Hint .. where no increase in price is sufficiently large to cause the person to decrease consumption of a necessity
What is the paradox of value and how is the paradox resolved?

49. Questions
Explain how a consumer’s income and the prices of goods limit consumption possibilities.
What is utility and how do we use the concept of utility to describe a consumer’s preferences?
What is the distinction between total utility and marginal utility?
What is the key assumption about marginal utility? Any contrary examples?
What two conditions are met when a consumer is maximizing utility?
What is the marginal utility per dollar and how is it calculated?
Explain why equalizing the marginal utility per dollar for all goods maximizes utility.

50. End of slides