1. Consumer Choice

2. How do you choose?

3. Consumer Choice • Consumer choice theory is based on the notion that consumers do the best they can, given the limitations dictated by their incomes and consumer prices.

4. Consumer Constraints:The Budget Line • Budget line: The line connecting all the combinations of two goods that exhaust a consumer’s budget. • Budget set: A set of points that includes all the combinations of goods that a consumer can afford, given the consumer’s income and the prices of the goods. • Price ratio: The ratio of the price of one good to the price of a second good; the market trade-off.

5. Consumer Preferences: Indifference Curves • Indifference curve: A curve showing the different combinations of two goods that generate the same level of utility or satisfaction. • Utility: The satisfaction experienced from consuming a product.

6. Consumer Preferences: Indifference Curves • Marginal rate of substitution (MRS): The rate at which a consumer is willing to trade or substitute one good for another. • The slope of the indifference curve is the marginal rate of substitution between two goods. • Superior combinations generate higher utility (point h). • Inferior combinations generate lower utility (point r). • Equivalent combinations generate the same utility (points on the curve).

7. Consumer Preferences: Indifference Curves • An indifference map shows a set of indifference curves, each with a different level of utility. • Utility increases as we move northeasterly to higher indifference curves (from C1 to C2 to C4 and so on).

8. Maximizing Utility • The consumer maximizes utility at tangency of an indifference curve and a budget line (point e). • Point z does not exhaust the entire budget. • Point b does not lie on the highest indifference curve that can be reached. • Point w is desirable but not affordable. • Point e generates maximum utility.

9. The Utility-Maximizing Rule:MRS = Price Ratio • Utility-maximizing rule: Pick the affordable combination that makes the marginal rate of substitution equal to the price ratio.

10. Drawing theDemand Curve • At a price of $3 per movie, utility is maximized with 4 movies and 18 books. • At a price of $2 per movie, utility is maximized with 7 movies and 16 books. • The individual demand for movies shows the quantity of movies demanded at each price level.

11. Applications of theConsumer Choice Model Music Piracy and Online Music Stores • When music is sold as bundles on CDs, the consumer has budget points rather than an entire budget line. Each CD carries 15 songs and has a price of $15, so the consumer buys songs in multiples of 15.

12. Applications of theConsumer Choice Model • Music Piracy and Online Music Stores • If songs are sold individually, the consumer has a full budget line and can legally reach his or her ideal combination of 6 songs and 48 arcade games (point i).

13. Applications of theConsumer Choice Model Inflation, the Real-Nominal Principle, and Consumer Choice • Inflation does not affect the consumer’s decision because it does not affect the budget set. This is an application of the real-nominal principle. The REAL-NOMINALPrincipleWhat matters to people is the real value of money or income—its purchasing power—not the “face” value of money or income.

14. Applications of theConsumer Choice Model The Equimarginal Rule • If the marginal benefit per dollar spent on one thing exceeds the marginal benefit per dollar spent on a second, do more of the first and less of the second. To get the best possible combination of the two things, pick the mix that equalizes the marginal benefit per dollar spent.