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Roger LeRoy Miller Economics Today

Roger LeRoy Miller Economics Today. Chapter 19 Consumer Choice. Once you pay a connection fee to an Internet service provider you incur no explicit fees for the cost of your time. The result may be that people spend “too much” time surfing the Web. Why?. Introduction. Learning Objectives.

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Roger LeRoy Miller Economics Today

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  1. Roger LeRoy Miller Economics Today Chapter 19 Consumer Choice

  2. Once you pay a connection fee to an Internet service provider you incur no explicit fees for the cost of your time. The result may be that people spend “too much” time surfing the Web. Why? Introduction

  3. Learning Objectives • Distinguish between total utility and marginal utility • Discuss why marginal utility at first rises but ultimately tends to decline as a person consumes more of a good or service

  4. Learning Objectives • Explain why an individual’s optimal choice of how much to consume of each good or service entails equalizing the marginal utility per dollar spent across all goods and services • Describe the substitution effect of a price change on the quantity demanded of a good or service

  5. Learning Objectives • Understand how the real-income effect of a price change affects the quantity of a good or service demanded • Evaluate why the price of diamonds is so much higher than the price of water even though people cannot survive long without water

  6. Chapter Outline • Utility Theory • Graphic Analysis • Diminishing Marginal Utility • Optimizing Consumption Choices • How a Price Change Affects Consumer Optimum • The Demand Curve Revisited

  7. Did You Know That... • More than 100 million people in the U.S. now have access to the Internet? • What determines how much people spend on computers, Internet access, and other family budget items?

  8. Utility Theory • Utility • The want-satisfying power of a good or service • Utility Analysis • The analysis of consumer decision making based on utility maximization • Util • A representative unit by which utilityis measured

  9. change in total utility Marginal utility = change in number of units consumed Utility Theory • Marginal Utility • The change in total utility due to a one-unit change in the quantity of a good or service consumed

  10. Total and Marginal Utilityof Watching Videos Figure 19-1, Panel (a)

  11. Graphic Analysis • A graph can be used to display the values displayed in the table to better see their relationships.

  12. Total and Marginal Utilityof Watching Videos Figure 19-1, Panel (b)

  13. Total and Marginal Utilityof Watching Videos Figure 19-1, Panel (c)

  14. 20 18 10 16 8 14 6 12 Total Utility (utils per week) 10 4 Marginal Utility (utils per week) 8 2 6 0 1 2 3 4 5 6 7 4 -2 2 -4 Videos Watched per Week 0 1 2 3 4 5 6 7 Videos Watched per Week Total and Marginal Utilityof Watching Videos Total utility is maximized... …where marginal utility equals zero. Figure 19-1, Panels (b) and (c)

  15. Total and Marginal Utilityof Watching Videos • Observations • Marginal utility falls • Marginal utility = 0 when total utility is at its maximum

  16. Diminishing Marginal Utility • Diminishing Marginal Utility • The principle that as more of any good or service is consumed, its extra benefit declines • Increases in total utility from consumption of a good or service become smaller and smaller as more is consumed during a given time period

  17. Newspaper Vending Machines versus Candy Vending Machines • How many people take more than one paper from the vending machine? • Why not dispense candy the same way?

  18. Optimizing Consumption Choices • Consumer Optimum • A choice of a set of goods and services that maximizes the level of satisfaction for each consumer, subject to limited income

  19. Total and Marginal Utility from Consuming Videos and Hamburgers on an Income of $26 Total Utility Marginal Utility Videos of Videos per Marginal Utility per Dollar per Period (utils) Spent (MUV/Pv) Period (utils) MUV (Price = $5) 0 0.0 —— —— 1 50.0 50.0 10.0 2 95.0 45.0 9.0 3 135.0 40.0 8.0 4 171.5 36.5 7.3 5 200.0 28.5 5.7

  20. Total and Marginal Utility from Consuming Videos and Hamburgers on an Income of $26 Total Utility Marginal Utility Hamburgers of Hamburgers Marginal Utility per Dollar per per Period (utils) Spent (MUV/Pv) Period (utils) MUV (price = $3) 0 0.0 —— —— 1 25 25 8.3 2 47 22 7.3 3 65 18 6.0 4 80 15 5.0 5 89 9 3.0

  21. Total and Marginal Utility from Consuming Videos and Hamburgers on an Income of $26 Marginal Utility Marginal Utility Items per Dollar per Dollar per Spent (Video) Spent (Hamburger) Period (price = $5) (price = $3) 0 —— —— 1 10.0 8.3 2 9.0 7.3 3 8.0 6.0 4 7.3 5.0 5 5.7 3.0

  22. Steps to Consumer Optimum Choices Videos Hamburgers Purchase Unit (MUV/PV) Unit (Muh/Ph) 1 First 10.0 First 8.3 2 Second 9.0 First 8.3 3 Third 8.0 First 8.3 4 Third 8.0 Second 7.3 5 Fourth 7.3 Second 7.3

  23. Steps to Consumer Optimum Buying Decision Remaining Income First video $26 - $5 = $21 Second video $21 - $5 = $16 First hamburger $16 - $3 = $13 Third video $13 - $5 = $ 8 Fourth video and $8 - $5 = $ 3 second hamburger $3 - $3 = $ 0

  24. Optimizing Consumption Choices • A little math • The rule of equal marginal utilities per dollar spent • A consumer maximizes personal satisfaction when allocating money income in such a way that the last dollars spent on good A, good B, good C, and so on yield equal amounts of marginal utility

  25. MU of good A MU of good B MU of good Z = = ... = price of good A price of good B price of good Z Optimizing Consumption Choices • A little math • The rule of equal marginal utilities per dollar spent

  26. QV = 4 Qh = 2 MUV MUh 22 36.5 = 7.3 = = 7.3 = 3 PV Ph 5 How a Price ChangeAffects Consumer Optimum Income = $26

  27. QV = 4 = 9.13 = Qh = 2 MUV MUh 22 36.5 = 7.3 = 3 PV Ph 4 How a Price ChangeAffects Consumer Optimum Assume Price of Videos Fall to $4

  28. Now > Result Buy more videos and MUV falls MUV MUh PV Ph How a Price ChangeAffects Consumer Optimum Assume Price of Videos Fall to $4

  29. Video Rental Pricesand Marginal Utility Figure 19-2

  30. How a Price ChangeAffects Consumer Optimum • The Substitution Effect • The tendency of people to substitute cheaper commodities for more expensive commodities

  31. How a Price ChangeAffects Consumer Optimum • The Principle of Substitution • Consumers and producers shift away from goods and resources that become relatively higher priced in favor of goods and resources that are now lower priced

  32. How a Price ChangeAffects Consumer Optimum • Purchasing Power • The value of money for buying goods and services

  33. How a Price ChangeAffects Consumer Optimum • Real-Income Effect • The change in people’s purchasing power that occurs when, other things being constant, the price of one good that they purchase changes

  34. How a Price ChangeAffects Consumer Optimum • What do you think? • Which would usually have more of an impact, the substitution or the real-income effect?

  35. The Demand Curve Revisited • Question • How is the demand curve derived? • Answer • By assuming income, tastes, expectations, and the price of related goods are not changing as the price and quantity demanded of the good changes

  36. The Demand Curve Revisited • Marginal utility, total utility, and the diamond-water paradox • Water is essential to life but cheap • Diamonds are not essential to life but expensive

  37. Pdiamonds Pwater Ddiamonds Dwater The Diamond-Water Paradox Price (dollars per kilogram) Quantity per Period (kilograms)

  38. S1 S2 Qdiamonds Qwater The Diamond-Water Paradox Pdiamonds Price (dollars per kilogram) Pwater Ddiamonds Dwater Quantity per Period (kilograms) Figure 19-3

  39. International Example:The World of Water in Saudi Arabia • Water is 5 times more expensive than gasoline. • Question • How can we explain this reversal of the U.S. prices?

  40. Issues and Applications:Should You Be Charged to Use the Internet? • A nearly zero price for Internet usage, after paying the internet service provider fee leads to Internet congestion. • The marginal utility per last dollar spent must be very low. • The price is not nearly zero because of the opportunity cost of time.

  41. Web Links • The following Web link appears in the margin of this chapter in the textbook: • http://www.finfacts.ie/Private/win_rst/ w_mar24.htm

  42. Summary Discussion of Learning Objectives • Total utility versus marginal utility • Total utility is total satisfaction from consumption • Marginal utility is the additional satisfaction from consuming an additional unit of a good • Law of diminishing marginal utility • Marginal utility eventually declines with additional consumption

  43. Summary Discussion of Learning Objectives • The substitution effect of a price change • A person will substitute among goods by buying less of a good when its price increases • The consumer optimum • Occurs when the marginal utility per dollar spent on each good is the same

  44. Summary Discussion of Learning Objectives • The real-income effect of a price change • A price change affects the purchasing power of a person’s income • Why the price of diamonds exceeds the price of water even though people cannot long survive without water • marginal utility determines how much people are willing to buy

  45. End of Chapter Chapter 19 Consumer Choice

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