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Chapter 20 Consumer Choice Cyberspace is challenging territory for those with visual impairments.

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chapter 20

Chapter 20

Consumer Choice

introduction

Cyberspace is challenging territory for those with visual impairments.

Because internet shopping is more difficult for those with disabilities, economic theory says that this adds to the cost of internet purchases. As a result, disabled consumers may buy less frequently from web-based retailers.

Introduction
learning objectives
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
learning objectives4
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
learning objectives5
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
chapter outline
Chapter Outline
  • Utility Theory
  • Graphical Analysis
  • Diminishing Marginal Utility
  • Optimizing Consumption Choices
  • How a Price Change Affects Consumer Optimum
  • The Demand Curve Revisited
did you know that
Did You Know That...
  • The pace of product innovation for new consumer goods is about twice as high as it was 20 years ago?
  • The economic analysis of consumer choice provides a way to account for all the variables of taste, income, and prices as they relate to individual decisions?
utility theory
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
utility theory9

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
graphical analysis
Graphical Analysis

Figure 20-1, Panel (b)

graphical analysis12
Graphical Analysis

Figure 20-1, Panel (c)

total and marginal utility of watching dvds13

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

DVDs Watched per Week

0

1

2

3

4

5

6

7

DVDs Watched per Week

Figure 20-1, Panels (b) and (c)

Total and Marginal Utilityof Watching DVDs

Total utility is

maximized...

…where marginal

utility equals zero.

total and marginal utility of watching videos
Total and Marginal Utilityof Watching Videos
  • Observations
    • Marginal utility falls as more is consumed
    • Marginal utility equals zero when total utility is at its maximum
diminishing marginal utility
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
example vending machines
Example: Vending Machines
  • How many people take more than one paper from the vending machine?
  • Why not dispense candy the same way?
  • The answer is found is the concept of diminishing marginal utility.
optimizing consumption choices
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
total and marginal utility from consuming dvds and pizza slices on an income of 26
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26

Total Utility Marginal Utility

DVDs of DVDs per Marginal Utility per Dollar

per Period (utils) Spent (MUd/Pd)

Period (utils) MUd (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

Table 20-1

total and marginal utility from consuming dvds and pizza slices on an income of 2619
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26

Total Utility Marginal Utility

Pizza Slices of Pizza Slices Marginal Utility per Dollar

per per Period (utils) Spent (MUpPp)

Period (utils) MUp (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

Table 20-1

total and marginal utility from consuming dvds and pizza slices on an income of 2620
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26

Marginal Utility Marginal Utility

Items per Dollar per Dollar

per Spent (DVD) Spent (Pizza)

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

Table 20-1

steps to consumer optimum
Steps to Consumer Optimum

Choices

DVDs

Pizza Slices

Purchase Unit (MUd/Pd) Unit (Mup/Pp)

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

Table 20-2

steps to consumer optimum22
Steps to Consumer Optimum

Buying Decision Remaining Income

First DVD $26 - $5 = $21

Second DVD $21 - $5 = $16

First pizza slice $16 - $3 = $13

Third DVD $13 - $5 = $ 8

Fourth DVD and $8 - $5 = $ 3

second pizza slice $3 - $3 = $ 0

Table 20-2

optimizing consumption choices23
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
optimizing consumption choices24

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
how a price change affects consumer optimum

Qd = 4

Qp = 2

MUd

MUp

22

36.5

= 7.3

=

= 7.3

=

3

Pd

Pp

5

How a Price ChangeAffects Consumer Optimum

Income = $26

how a price change affects consumer optimum26

Qd = 4

= 9.13

=

Qp = 2

MUd

MUp

22

36.5

= 7.3

=

3

Pd

Pp

4

How a Price ChangeAffects Consumer Optimum

Assume Price of DVDs Falls to $4

how a price change affects consumer optimum27

Now

>

Result

Buy more DVDs and MUd falls

MUd

MUp

Pd

Pp

How a Price ChangeAffects Consumer Optimum

Assume Price of DVDs Falls to $4

dvd rental prices and marginal utility

A

B

D

DVD Rental Pricesand Marginal Utility

5

Price per Unit ($ per DVD)

4

0

1

2

3

Figure 20-2

DVD Rentals per Week

how a price change affects consumer optimum29
How a Price ChangeAffects Consumer Optimum
  • The Substitution Effect
    • The tendency of people to substitute cheaper commodities for more expensive commodities
how a price change affects consumer optimum30
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
how a price change affects consumer optimum31
How a Price ChangeAffects Consumer Optimum
  • Purchasing Power
    • The value of money for buying goods and services
how a price change affects consumer optimum32
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
how a price change affects consumer optimum33
How a Price ChangeAffects Consumer Optimum
  • What do you think?
    • Which would usually have more of an impact on your purchases: the substitution effect or the real-income effect?
the demand curve revisited
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 of the good changes
e commerce example virtual 3d pays off at lands end
E-Commerce Example:Virtual 3D Pays Off at Lands’ End
  • The retailer Lands’ End provides shoppers with a 3D simulation of clothing items on a model with measurements customized to match those of the shopper.
  • Such a feature helps reduce the customer’s uncertainty.
  • Evidence collected so far indicates that Lands’ End shoppers are willing to pay higher prices for this feature.
the demand curve revisited36
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
the diamond water paradox

Pdiamonds

Pwater

Ddiamonds

Dwater

The Diamond-Water Paradox

Price (dollars per kilogram)

Quantity per Period

(kilograms)

Figure 20-3

the diamond water paradox38

S2

S1

Qdiamonds

Qwater

The Diamond-Water Paradox

Pdiamonds

Price (dollars per kilogram)

Pwater

Ddiamonds

Dwater

Quantity per Period

(kilograms)

Figure 20-3

international example the world of water in saudi arabia
International Example:The World of Water in Saudi Arabia
  • Water is five times more expensive than gasoline in Saudi Arabia.
  • Question
    • How can we explain this reversal of the U.S. prices?
issues and applications internet shopping with disabilities
Issues and Applications:Internet Shopping with Disabilities
  • Web pages are most easily used by those without visual impairments, especially because most are not accompanied by audio files to assist in navigation.
  • If you have difficulty navigating a website, then any purchase you make has an added cost.
issues and applications internet shopping with disabilities41
Issues and Applications:Internet Shopping with Disabilities
  • As more websites become better equipped with voice instructions, they will be more easily used by those who cannot navigate the site visually.
  • Already, the presence of more aids for the disabled has contributed to an increasing volume of internet commerce.
summary discussion of learning objectives
Summary Discussionof 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
summary discussion of learning objectives43
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
summary discussion of learning objectives44
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
end of chapter 20

End of Chapter 20

Consumer Choice