1. Chapter 6 Consumer Choice Theory
Lecture Slides
Economics for Today Irvin B. Tucker
© 2011 South-Western, a part of Cengage Learning

2. What does this chapter cover?
It expands the understanding of demand by investigating why people buy goods and services
© 2011 South-Western, a part of Cengage Learning

3. © 2011 South-Western, a part of Cengage Learning
What does utility mean?
The satisfaction, or pleasure, that people receive from consuming a good or service
© 2011 South-Western, a part of Cengage Learning

4. © 2011 South-Western, a part of Cengage Learning
What is total utility?
The amount of satisfaction received from all the units of a good or service consumed
© 2011 South-Western, a part of Cengage Learning

5. Why does a consumer buy one bundle of goods, rather than another?
Consumers make one choice over another depending on their marginal utility
© 2011 South-Western, a part of Cengage Learning

6. What is marginal utility?
The change in total utility from one additional unit of a good or service
© 2011 South-Western, a part of Cengage Learning

7. What is the law of diminishing marginal utility?
The principle that the extra satisfaction of a good or service declines as people consume more in a given period
© 2011 South-Western, a part of Cengage Learning

8. MU 8 6 4 2 Exhibit 1(a) Marginal Utility 0 1 2 3 4
Marginal Utility per Big Mac (utils) 4 2 MU
Quantity of Big Macs (number consumed per day) 8
© 2011 South-Western, a part of Cengage Learning

9. TU Exhibit 1(b) Total Utility 16 12 8 4 0 1 2 3 4
Total Utility (utils) 8 4
Quantity of Big Macs (number consumed per day) 9
© 2011 South-Western, a part of Cengage Learning

10. When is total utility maximized?
When the marginal utility per dollar of each good is equal and the entire budget is spent
© 2011 South-Western, a part of Cengage Learning

11. What is consumer equilibrium?
A condition in which total utility cannot increase by spending more of a given budget on one good and spending less on another good
© 2011 South-Western, a part of Cengage Learning

12. © 2011 South-Western, a part of Cengage Learning
Even though water provides a greater utility than diamonds, why are diamonds more expensive?
Water is plentiful in most of the world, so its marginal utility is low
© 2011 South-Western, a part of Cengage Learning

13. S MU Exhibit 2(a) Marginal Utility of Diamonds
Marginal Utility per Carat (utils)
MUd MU
Quantity of Diamonds (carats per year) 13
© 2011 South-Western, a part of Cengage Learning

14. S MU MUw Exhibit 2 Marginal Utility of Water
Marginal Utility per gallon (utils) MU
MUw
Quantity of Water (gallons per year) 14
© 2011 South-Western, a part of Cengage Learning

15. Exhibit 3 Marginal Utility for Big Macs and Milkshakes (utils per day)
Quantity MU
MU/P MU
MU/P 1 2 3 4 8 4 2 1 4 2 1
1/2 6 4 1 3 2
1/2
Note: The price per Big Mac and per milkshake is $2.
© 2011 South-Western, a part of Cengage Learning

16. © 2011 South-Western, a part of Cengage Learning
Consumer Equilibrium
MU A
price A
MU B
price B
MU Z
price Z = =
© 2011 South-Western, a part of Cengage Learning

17. Consumer Equilibrium Price of Big Mac = $2
MU of Big Mac
price of Big Mac
MU of milkshake
price of milkshake =
4 utils $2
4 utils $2 =
© 2011 South-Western, a part of Cengage Learning

18. Consumer Equilibrium Price of Big Mac = $1
MU of Big Mac
price of Big Mac
MU of milkshake
price of milkshake
>
4 utils $1
>
4 utils $2
© 2011 South-Western, a part of Cengage Learning

19. What happens to the number of Big Macs bought when the price drops?
To restore maximum total utility, the consumer spends more on Big Macs
© 2011 South-Western, a part of Cengage Learning

20. What does this discussion of utility reveal?
The law of demand, that is, as the price of a good declines, consumers will buy more units of the good, and vice versa
© 2011 South-Western, a part of Cengage Learning

21. What are two alternative explanations of demand?
Income effect
Substitution effect
© 2011 South-Western, a part of Cengage Learning

22. What is the income effect?
The change in quantity demanded of a good or service caused by a change in real income (purchasing power)
© 2011 South-Western, a part of Cengage Learning

23. What does the income effect show?
As prices decline, your real income increases, increasing your buying power, so you buy more units, ceteris paribus
© 2011 South-Western, a part of Cengage Learning

24. Quantity demanded of good X increases
Real purchasing power increases
Price of good X falls
© 2011 South-Western, a part of Cengage Learning

25. What is the substitution effect?
The change in quantity demanded of a good or service caused by the change in its price relative to substitutes
© 2011 South-Western, a part of Cengage Learning

26. What does the substitution effect show?
Suppose the price of a Pepsi falls and the price of a Coke remains unchanged; you will buy more Pepsi, because relatively, it is less expensive than Coke
© 2011 South-Western, a part of Cengage Learning

27. Quantity demanded of good X increases
Consumers switch from good Y to good X
Price of competing good Y rises
© 2011 South-Western, a part of Cengage Learning

28. What do the substitution and income effects prove?
The law of demand, that is, as the price of a good declines, consumers will buy more units of the good, and vice versa
© 2011 South-Western, a part of Cengage Learning

29. END