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Chapter 6 Consumer Choice Theory Key Concepts Summary Practice Quiz Internet Exercises ©2000 South-Western College Publishing In this chapter, you will learn to solve these economic puzzles:

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chapter 6 consumer choice theory
Chapter 6Consumer Choice Theory
  • Key Concepts
  • Summary
  • Practice Quiz
  • Internet Exercises

©2000 South-Western College Publishing

in this chapter you will learn to solve these economic puzzles
In this chapter, you will learn to solve these economic puzzles:

Under what conditions might you be willing to pay $10,000 for a gallon of water and 1 cent for a one-carat diamond?

When ordering Big Macs, milkshakes, pizza, and other goods, how can you obtain the highest possible satisfaction?

Do white rats obey the law of demand?

what is util
What is Util?

A hypothetical unit used to measure how much utility a person obtains from consuming a good

what is utility
What is Utility?

The satisfaction, or pleasure, that people receive from consuming a good or service

what is total utility
What is Total Utility?

The amount of satisfaction received from all the units of a good or service consumed

why does a consumer buy one bundle of goods rather than another
Why does a consumer buy one bundle of goods, rather than another?

Consumers make one choice over another depending on their marginal utility

what is marginal utility
What is Marginal Utility?

The change in total utility from one additional unit of a good or service

what is the law of diminishing marginal utility
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

slide9

Diminishing Marginal Utility

8

6

Marginal Utility

4

2

MU

Q

1

2

3

4

slide10

Total Utility

16

TU

Utils

12

8

4

Q

1

2

3

4

when is total utility maximized
When is Total Utility maximized?

When the marginal utility per dollar of each good is equal and the entire budget is spent

what is consumer equilibrium
What isConsumer 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

even though water provides a greater utility than diamonds why are diamonds more expensive
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

slide14

Marginal Utility of Diamonds

S

8

6

Marginal Utility

4

MUd

2

MU

Q

1

2

3

4

slide15

Marginal Utility of Water

S

8

6

Marginal Utility

4

2

MUw

MU

Q

1

2

3

4

slide16

Marginal Utility for Big Macs and Milkshakes (utils per day) ($2 each)

BIG MACS

MILKSHAKES

Quantity

MU

MU/P

MU

MU/P

1

2

3

4

8

4

2

1

4

2

1

1/2

6

4

1

0

3

2

1/2

0

slide17

Consumer Equilibrium

MU A

price A

MU B

price B

MU Z

price Z

=

=

slide18

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

=

slide20

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

what happens to the number of big macs bought when the price drops
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

what does this discussion of utility reveal
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

what are two alternative explanations of demand
What are two alternative explanations of demand?

Income effect

Substitution effect

what is the income effect
What is theIncome effect?

The change in quantity demanded of a good or service caused by a change in real income (purchasing power)

what does the income effect show
What does the Income effect show?

As prices decline, your real income increases, increasing your buying power, so you buy more units, ceteris paribus

what is the substitution effect
What is theSubstitution effect?

The change in quantity demanded of a good or service caused by the change in its price relative to substitutes

what does the substitution effect show
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

what does the substitution and income effect prove
What does the Substitution and Income effect 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

what is a normal good
What is a Normal Good?

A good that consumers will buy more of as their incomes increase

what is an inferior good
What is anInferior Good?

A good that consumers will buy less of as their incomes increase

key concepts32
Key Concepts
  • What is Util?
  • What is Utility?
  • What is Total Utility?
  • What is Marginal Utility?
  • What is the Law of Diminishing Marginal Utility?
  • When is Total Utility maximized?
  • What is Consumer Equilibrium?
key concepts cont
Key Concepts cont.
  • What are two alternative explanations of demand?
  • What is the Income effect?
  • What is the Substitution effect?
  • What does the Substitution and Income effect prove?
  • What is a Normal Good?
  • What is an Inferior Good?
slide35

Utility is the satisfaction or pleasure derived from consumption of a good or service. Actual measurement of utility is impossible, but economists assume it can be measured by a fictitious unit called the util.

slide36

Total utility is the total level of satisfaction derived from all units of a good or service consumed. Marginal utility is the change in total utility from a one unit change in the quantity of a good or service consumed.

slide37

Diminishing Marginal Utility

8

6

Marginal Utility

4

2

MU

Q

1

2

3

4

slide38

Total Utility

16

TU

Utils

12

8

4

Q

1

2

3

4

slide39

The law of diminishing marginal utility states that marginal utility of a good or service eventually declines as consumption increases.

slide40

Consumer equilibrium is the condition of reaching the maximum level of satisfaction, given a budget, when the marginal utility per dollar spent on each good purchased is equal.

slide41

Consumer equilibrium and the law of diminishing marginal utility can be used to derive a downward-sloping demand curve. When the price of a good falls, consumer equilibrium no longer holds because the marginal utility the marginal utility per dollar for the good rises.

slide42

To restore equilibrium, the consumer must increase consumption. As the quantity demanded increases, the marginal utility falls until equilibrium is again achieved. Thus, the price falls and the quantity demanded rises, as predicted by the law of demand

slide43

Consumer Equilibrium

MU A

price A

MU B

price B

MU Z

price Z

=

=

slide44

The income effect and the substitution effect are complementary explanations for the law of demand. When the price changes, these effects work in combination to change in the quantity demanded in the opposite directions.

slide45

As the price falls, real purchasing power increases, causing an increase in the consumer’s willingness and ability to purchase a good or service. This is the income effect. Also, as the price falls, the consumer substitutes the cheaper the cheaper good for other goods that are now relatively more expensive. This is the substitution effect.

slide46

If the marginal utility per last dollar spend on each good is equal and the entire budget is spent, total utility is maximized.

slide47

When the price of a normal good falls, the income effect and the substitution effect combine to cause the quantity demanded to increase.

chapter 6 quiz
Chapter 6 Quiz

©2000 South-Western College Publishing

slide49
1. As an individual consumes more of a given good, the marginal utility of that good to the consumer

a. rises at an increasing rate.

b. rises at a decreasing rate.

c. falls.

d. rises.

C. As a consumer consumes more and more of anything, the satisfaction received on the last unit becomes less and less with each unit.

slide50
2. The amount of added utility that a consumer gains from the consumption of one more unit of a good is called

a. incremental utility.

b. total utility.

c. diminishing utility.

d. marginal utility.

D. The word “margin” means that last unit or the last increment.

slide51
3. A certain consumer buys only food and compact discs. If the quantity of food bought increases, while that of compact discs remains the same, the marginal utility of food will

a. fall relative to the marginal utility of compact discs.

b. rise relative to the marginal utility of compact discs.

c. rise, but not as fast as the marginal utility of compact discs falls.

d. fall, but not as fast as the marginal utility of compact discs falls.

A. As more units of food are purchased, the marginal utility diminishes, while that of compact discs remains the same.

slide52
4. Rational consumers will continue to consume two goods until

a. the marginal utility per dollar’s worth of the two goods is the same.

b. the marginal utility is the same for each good.

c. the prices of the two goods are equal.

d. the prices of the two goods are unequal.

A. If a consumer can raise his/her marginal utility by purchasing more of a good, more units of that good will be purchased. At the point that marginal utility cannot be increased by purchasing more units of either good, the consumer will stop purchasing.

slide53
5. Assume a person’s consumption of just the right amounts of pork and chicken is in equilibrium. We can conclude that the

a. marginal utility of pork must equal the marginal utility of chicken.

b. price of pork must equal the price of chicken.

c. ratio of marginal cost to price must be the same in both the pork and the chicken markets.

d. ratio of marginal utility to price must be the same for pork and chicken.

D. In terms of satisfaction, the two goods become identical at the point of equilibrium.

slide54
6. Assume an individual consumes only milk and doughnuts, and he/she has arranged consumption so that the last glass of milk yields 12 utils and the last doughnut 6 utils. If the price of milk is $1 per glass and the price of a doughnut is $.50, we can conclude that the

a. consumer should consume less milk and more doughnuts.

b. price of milk is too high relative to doughnuts.

c. consumer should consume more milk and fewer doughnuts.

d. consumer is in equilibrium.

D. At this point, the ratio of utils to price is the same.

slide55
7. Suppose an individual consumes pizza and cola. To reach consumer equilibrium, the individual must consume pizza and cola so that the

a. price paid for the two goods is the same.

b. marginal utility of the two goods is equal.

c. ratio of marginal utility to price is the same for both goods.

d. ratio of marginal utility of cola to marginal utility of pizza is 1.

C. When the ratio of utils to price is the same for two goods, the consumer cannot increase his/her satisfaction by buying more of either.

slide56
8. A state of consumer equilibrium for goods consumed prevails when the

a. marginal utility of all goods is the same.

b. marginal utility per dollar’s worth of two goods is the same.

c. price of two goods is the same.

d. marginal cost per dollar spent on two goods is the same.

B. When the marginal utility of two goods is the same, the consumer cannot increase his/her level of satisfaction by purchasing more of either good.

slide57
9. The change in quantity demanded resulting from a change in purchasing power is known as the

a. income effect.

b. substitution effect.

c. law of demand.

d. consumer equilibrium effect.

A. When prices decline the purchasing power of the consumer increases, and vice versa. Therefore, a change in prices has the same effect on the buying power of the consumer as if his/her income had changed.

slide58

Total Utility for Multiplex Tickets, Video Rentals, and Popcorn

Total Utility from Multiplex Tickets

Total Utility from Video Rentals

Total Utility from Popcorn

1 bag (8 utils)

2 bags (13 utils)

3 bags (15 utils)

4 bags (16 utils)

1 movie (30 utils)

2 movies (54 utils)

3 movies (72 utils)

4 movies (84 utils)

1 video (14 utils)

2 videos (24 utils)

3 videos (30 utils)

4 videos (32 utils)

Exhibit 4

slide59
10. In exhibit 4, assume Multiplex tickets cost $6 each, video rentals cost $2 each, and bags of popcorn cost $1 each. What is the marginal utility of renting a third video?

a. 6 utils.

b. 8 utils.

c. 10 utils.

d. 30 utils.

A. If the total utility for 2 videos is 24 utils and the total utility for 3 videos is 30 utils, the additional utils added by the third video is 6.

slide60
11. In exhibit 4, assume Multiplex tickets cost $6 each, video rentals cost $2 each, and bags of popcorn cost $1 each. Suppose the consumer has $12 per week to spend on Multiplex tickets, video rentals, and popcorn. What combination of goods will give the consumer the most utility?

a. 1 movie, 3 videos, and no popcorn.

b. 1 movie, 2 videos, and 2 bags of popcorn.

c. 1 movie, 1 video, and 4 bags of popcorn.

d. 2 movies, no video, and no bags of popcorn.

B. 67 total utils are achieved with this combination, a yields 60 utils, c yields 60 utils and d yields 54 utils.

internet exercises
Internet Exercises

Click on the picture of the book, choose updates by chapter for the latest internet exercises.