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Chapter 5. Consumer Choice. Utility Consumer surplus Budget Constraints Indifference Curves. I. Utility Analysis. what is utility? benefit you get from consuming a good determined by your tastes/preferences (assume these are stable). total utility (TU).

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chapter 5 consumer choice
Chapter 5. Consumer Choice
  • Utility
  • Consumer surplus
  • Budget Constraints
  • Indifference Curves
i utility analysis
I. Utility Analysis
  • what is utility?
    • benefit you get from consuming a good
    • determined by your tastes/preferences

(assume these are stable)

total utility tu
total utility (TU)
  • total benefit from consuming good
  • example
    • total benefit from 3 cookies
slide4

TU 2 cookies

TU 3 cookies

  • TU increases as consumption increases, to a point

<

marginal utility mu
marginal utility (MU)
  • change in TU from

consuming one more of a good

  • example
    • how much MORE utility from

an additional pack of gum?

slide6

0

change in TU from

0 to 1 cookie

MU of 1st cookie

=

change in TU from

1 cookie to 2 cookies

=

MU of 2nd cookie

diminishing marginal utility
diminishing marginal utility
  • MU falls as consumption rises
  • get sick of cookies
slide8

0

MU of 1st cookie

>

MU of 2nd cookie

slide9

TU

cookie

MU

cookie

TU rises at slower and slower rate

as MU declines

how to maximize tu
How to maximize TU?
  • use available budget
  • equalize MU/$ across goods
  • Huh?
slide11

MU cookies

MU milk

=

  • chose combination of cookies and milk where

price of cookies

price of milk

slide12
why?
  • chose combo of 6 cookies, 1 milk
  • suppose MU/$1 of cookies = 4,

MU/$1 of milk = 15

  • by consuming fewer cookies, more milk…

I would add more to my TU

tu vs mu
TU vs. MU
  • Diamond-Water paradox
  • $10,000
    • one carat diamond
    • 5 million gallons of tap water
slide14
why?
  • TU of water is greater than TU of diamonds
    • water is essential for life
  • BUT water is abundant, diamonds are rarer
    • MU of last diamond is higher
  • MU determines value
mu and demand
MU and demand
  • MU declines as consumption rises
  • willing to pay less for each additional unit
    • downward sloping demand
example pizza

P

willing to pay $15

$15

$10

willing to pay $10

D

Q

2 pizza

4 pizzas

example : pizza

for 2nd pizza

for 4th pizza

ii consumer surplus
II. Consumer Surplus
  • difference between what you pay for a good,

any what you are WILLING to pay for a good

example
example
  • market price pizza = $10
  • my marginal value of 3rd pizza this week = $12
  • my consumer surplus = $2
my demand curve

P

$12

my consumer surplus

$10

D

Q

3

my demand curve
slide20

total consumer surplus

P

$10

D

Q

10,000

area between D

and price of pizza

iii the budget line
III. The Budget Line
  • given:
    • consumer’s budget
    • prices
  • draw a line representing choices
  • consumption possibilities
example1
example
  • 2 goods: milk & cookies
  • bottle of milk = $1
  • cookie = $.50
  • daily budget = $4
possible combinations

milk

cookies

possible combinations

0

2

4

6

8

4

3

2

1

0

budget line

8

6

4

2

0

1

2

3

4

budget line

cookies

milk

budget line1

8

6

4

2

0

1

2

3

4

budget line

cookies

Unaffordable

Affordable

milk

what if prices change
what if prices change?
  • changes slope of budget line
  • suppose cookies = $1
budget line2

cookie = $.50

8

6

cookie = $1

4

2

0

1

2

3

4

budget line

cookies

milk

what if budget changes
what if budget changes
  • budget line shifts
  • suppose budget = $5
slide29

10

8

6

budget = $5

4

budget = $4

2

0

1

2

3

4

5

cookies

milk

iv indifference curves
IV. Indifference Curves
  • (appendix)
  • alternative way to show utility
  • curve shows combo of goods

that deliver same total utility

example milk and cookies

8

6

4

2

Indifference curve

0

1

2

3

4

example: milk and cookies

cookies

Every point on curve has same total utility

milk

consumer equilibrium
consumer equilibrium
  • maximize TU
  • stay on budget
consumer equilibrium1

cookies

8

4

milk

4

2

consumer equilibrium

best affordable point

consumer equilibrium2

cookies

8

4

milk

4

2

consumer equilibrium

best affordable point

sum it up
sum it up
  • consumer decisions based on
    • preferences
    • budget constraint
  • consumer decisions made at the margin
    • marginal benefit of one more
    • compared to price of one more