Chapter 5. Consumer Choice

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# Chapter 5. Consumer Choice - PowerPoint PPT Presentation

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

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Presentation Transcript
Chapter 5. Consumer Choice
• Utility
• Consumer surplus
• Budget Constraints
• Indifference Curves
I. Utility Analysis
• what is utility?
• benefit you get from consuming a good

(assume these are stable)

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

• TU increases as consumption increases, to a point

<

marginal utility (MU)
• change in TU from

consuming one more of a good

• example
• how much MORE utility from

0

change in TU from

=

change in TU from

=

diminishing marginal utility
• MU falls as consumption rises

0

>

TU

MU

TU rises at slower and slower rate

as MU declines

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

MU milk

=

• chose combination of cookies and milk where

price of milk

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
• \$10,000
• one carat diamond
• 5 million gallons of tap water
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 declines as consumption rises
• willing to pay less for each additional unit
• downward sloping demand

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
• difference between what you pay for a good,

any what you are WILLING to pay for a good

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

P

\$12

my consumer surplus

\$10

D

Q

3

my demand curve

total consumer surplus

P

\$10

D

Q

10,000

area between D

and price of pizza

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

milk

possible combinations

0

2

4

6

8

4

3

2

1

0

8

6

4

2

0

1

2

3

4

budget line

milk

8

6

4

2

0

1

2

3

4

budget line

Unaffordable

Affordable

milk

what if prices change?
• changes slope of budget line

8

6

4

2

0

1

2

3

4

budget line

milk

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

10

8

6

budget = \$5

4

budget = \$4

2

0

1

2

3

4

5

milk

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

that deliver same total utility

8

6

4

2

Indifference curve

0

1

2

3

4

Every point on curve has same total utility

milk

consumer equilibrium
• maximize TU
• stay on budget

8

4

milk

4

2

consumer equilibrium

best affordable point

8

4

milk

4

2

consumer equilibrium

best affordable point

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