1. Consumer Choice and Demand
Chapter 6
Consumer Choice and Demand
© 2006 Thomson/South-Western

2. Utility Analysis
Utility: the sense of pleasure, or satisfaction, that comes from consumption
Tastes: preferences for different goods and services  likes and dislikes

3. Total and Marginal Utility
Total utility is the total satisfaction a person derives from consumption
Marginal utility is the change in total utility resulting from a one-unit change in consumption of a good
Law of Diminishing Marginal Utility
The more of a good an individual consumes per time period, other things constant, the smaller the increase in total utility from additional consumption

4. Exhibit 1: Utility Derived from Water
The first column lists possible quantities of water a person might consume after running on a hot day.
The second column presents the total utility derived from that consumption.
The third column presents the marginal utility of each additional glass of water consumed  change in total utility from consuming an additional unit.
Units of Water
Consumed Total Marginal
(8 ounce glass) Utility Utility

5. Exhibit 2: Total and Marginal Utility
Total Utility
Marginal utility begins to diminish with the first unit
Each glass adds less to total utility
Total utility increases for the first four glasses, but at a decreasing rate
In a world without scarcity the price of water is zero – a person would consume 4 glasses of water
Marginal Utility

6. Utility Maximization with Scarcity
Issue here becomes one of maximizing utility subject to the constraint that your income is limited and prices are greater than zero
Suppose that we have the following bits of information
The price of pizza is $8
The rental price of a movie video is $4
After tax income equals $40 per week

7. Exhibit 3: Pizza & Video Rentals
Marginal Marginal Utility Utility
of Pizza of Videos
Pizza Total Marginal per Dollar Video Total Marginal per Dollar
Consumed Utility Utility Expended Rentals Utility of Utility of Expended
Per Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4)
(1) (2) (3) (4) (5) (6) (7) (8) ¼ ½ ½
You spend your entire budget of $40 on pizza  5 pizzas per week at a total utility of 142
Giving up one pizza frees up enough money to rent two videos, and total utility increases from 142 to 198
Reducing consumption to three pizzas further increases total utility from 198 units to 212 units  another utility-increasing move

8. Utility-Maximizing Condition
Consumer equilibrium is achieved when the budget is completely spent and the last dollar spent on each good yields the same utility
Where MUp is the marginal utility of pizza, pp is the price of pizza, MUv is the marginal utility of videos, and pv the price of videos

9. Law of Demand and Marginal Utility
We now have a single point on the demand curve for pizzas
At a price of $8, the quantity demanded was 3 pizzas per week, based on a given income of $40 per week, a given rental price of $4 per video, and tastes as reflected in the utility numbers
To generate another point, suppose the price of pizza declines to $6  Exhibit 4 is the same as Exhibit 3 except that the price of pizza has been reduced

10. Exhibit 4: Pizza & Video Rentals
Marginal Marginal Utility Utility Pizza Total Marginal per Dollar Video Total Marginal per Dollar
Consumed Utility Utility Expended Rentals Utility of Utility of Expended
Per Week of Pizza of Pizza (price=$8) per Week Videos Videos (price=$4)
(1) (2) (3) (4) (5) (6) (7) (8) / /
/ ½
Based on the new lower price of pizza we would have $6 unspent. We would increase our consumption to 4 pizzas per week  total utility increases by the 18 units derived from the 4th pizza. We are once again in equilibrium.
Have another point on the demand curve for pizza, Price = $6, Qd = 4 pizzas

11. Exhibit 5: Demand for Pizza Generated from Marginal Utility
The original position of consumer equilibrium is at point a, where the consumer purchased 3 units of pizza
After the price declines to $6, the consumer purchases 4 units of pizza, as shown by point b a $8 a z z i p b r 6 e p e c i r P 4 2 D 1 2 3 4
Pizzas per week

12. Exhibit 6: Consumer Surplus$8 7
When price = $8, the marginal utility of other goods is higher than the marginal utility of a Subway
If price = $7, consumer is willing and able to buy one per month, at $6, two are purchased; at $5, three are purchased, and so on
If the market price is $4 – less than the consumer is willing to pay – this is a consumer surplus 6
Price per Subway 5 4 3 2 1 D 1 2 3 4 5 6 7 8
Subways per month

13. Exhibit 7: Summing Individual Demands to Derive Market Demand
(d) Market demand
for Subways
(a) You
(b) Brittany
(c) Chris e $6 c $6 $6 $6
dY + dB + dC = D i r P 4 4 4 4 2 2 2 d d d 2 Y B C 2 4 6 2 4 2
Subways per month
At a price of $4, you demand 4 Subways, Brittany 2, and Chris none: the market demand at a price of $4 equals 6
When the price is $2, your quantity demanded is 6, Brittany’s is 4, and Chris’s is 2: market demand = 12
The market demand shows the total quantity demanded per period by all consumers at various prices

14. Exhibit 8: Market Demand and Consumer Surplus
The market price is $2
All consumers adjust their quantity demanded until the marginal valuation of the last unit purchased equals $2
However, each consumer gets to buy all other units for $2 each
The shaded area depicts the consumer surplus when the price is $2
This area shows the increase in consumer surplus if the price falls to $1
Price per unit $2 1 D
Quantity per period

15. Consumer Surplus
Consumer surplus is the net benefit consumers get from market exchange
It can be used to measure economic welfare and to compare the effects of such concepts as
Different market structures
Different tax structures
Different public expenditure programs

16. Role of Time in Demand
Because consumption does not occur instantaneously, time also plays an important role in demand analysis
The cost of consumption has two components
The money price of the good
The time price of the good

17. Role of Time in Demand
Other things constant, a good or service that provides the same benefit in less time is preferred
The premium for time-saving goods and services depends on the opportunity cost of a persons time
Differences in the value of time among consumers help explain differences in the consumption patterns observed in the economy