Consumer Choice

1
Consumer Choice

• Igor Lukashin
• ECN112 Micro Principles
• February 10, 1999

2
Consumer Decision Problem

• Problem
• Allocate limited budget (money, time, resources)
  among various goods services
• Give examples of your budget-constrained choices
• Intuitive (Folk) Solution
• Get the most bang for your buck
• Define bang in the above sentence

3
Consumers ARE Different

• Classmates allocate lots of time to different
  activities
• Swim, read, sing, play/listen to music, pilot a
  plane, etc
• Q If youre good at something, do you spend a
  lot of time doing it?
• Moons followers agree to marriage to a randomly
  selected partner

4
Consumers Have a Common Decision Rule

• Compare perceived costs perceived benefits
  among various alternatives
• Select those that they believe give them the
  greatest relative benefits
• How can you compare avoid comparing apples to
  oranges?

5
Comparisons the Concept of Utility

• Utility
• a measure of the satisfaction received from
  possessing or consuming good or service
• Utility is an abstract concept
• Util unit of measurement
• Behavior Consumers maximize utility

6
Consumer Choice Steps of the Scientific Method
7
Utility Function Marginal Utility

• Utility Function
• Given a quantity of a good or service
• Returns a number measuring level of satisfaction
  associated with that good or service
• Marginal Utility
• Extra utility derived from consuming one more
  unit of a good or service

8
Diminishing Marginal Utility

• Law
• Principle that the more of a good that one
  obtains
• in a specific period of time,
• the less is the additional utility yielded by an
  additional unit of that good
• Cola drinking demonstration
• How much cola can you drink?
• When do you stop and why?

9
Utility More Definitions

• Disutility
• Dissatisfaction
• Total utility
• A measure of the total satisfaction derived from
  consuming a quantity of some good or service

10
Diminishing MU Always? For Everyone?

• Time Period
• Longer gt diminishing not as fast
• As soon as time period is defined, diminishing
  marginal utility applies
• Different Consumers
• Total Marginal Utilities would be different
• Diminishing MU applies for each separate consumer
• NO UTILITY COMPARISONS BETWEEN DIFFERENT
  CONSUMERS!

11
Example All You Can Eat

• How can those restaurants stay in business?
• Diminishing Marginal Utility
• Stop eating when
• Marginal Utility ZERO
• How do you choose if thats a good deal given
  price and types of food available?

12
Recap

• Utility
• the degree to which goods and services satisfy
  wants
• Total Utility
• total satisfaction from consuming a given good
• Marginal Utility (MU)
• utility an additional unit of a good or service
  yield
• Diminishing Marginal Utility
• MU declines with each additional unit of a good

13
Marginal Utility and Choice

• Intuitive Decision Rule
• the most bang for your buck
• translates into
• select a good for which Marginal Utility of a
  dollars worth quantity of good is the greatest
• 1 buys 1.125 lbs of apples (P?)
• 1 buys 5 lbs of bananas COMPARE
• MU(5 lbs bananas) and MU(1.125 lbs).
• Get the bundle with greater MU. Repeat (if more )

14
Discrete Goods Example

• CD costs 15 bucks
• Whats the utility of 1/15 CD?
• Can get 0,1,2 cant get fractions.
• Most bang for your buck
• replaced with
• average marginal utility per dollar spend
• Take MU of ONE CD
• Divide it by CD Price

15
Consumer Equilibrium

• Equimarginal Principle
• to maximize utility,, consumers must allocate
  their scarce incomes among goods so as to equate
  thee marginal utilities per dollar of expenditure
  on the last unit of each good purchased

16
Demand Curve Why Downward-Sloping?

• Demand curve can be derived from consumer
  equilibrium by altering the price of one good or
  service
• Extra unit purchased only if MU/P gt or MU/P of
  other goods or services

P1
Q1
17
Demand Curve Why Downward-Sloping?

• Demand curve is downward sloping
• because of
• Diminishing Marginal Utility

P1
Q1
18
Consumer Surplus

• Consumer Surplus
• the difference between what the consumer is
  willing to pay for a unit of good and the price
  that the consumer actually has to pay
• P .4 CS?

Consumer Surplus 3rd Unit
19
Disneyland and Consumer Surplus

• Charge admission
• Rides are free
• P 0
• CS 1.0 .9 .8 . .2 .1 ((1.0
  ..1)/2)10 5.5
• Charge 5.50 admission
• Are the rides free?

Consumer Surplus 3rd Unit
CS of the 10th unit
20
Demand Shifts the Determination of Market Demand

• If Price of a good falls, ceteris paribus
• Other goods become relatively more expensive
  (substitution)
• the good purchased prior to the price change now
  costs less, so consumers can buy more of all
  goods (income)

Consumers now have extra income
21
Substitution and Income Effects of a Price Change

• Price of a good changes
• Substitution effect
• indicates that following a decrease in the price
  of a good, an individual will purchase more of
  the now less-expensive good and less of other
  goods
• Income effect
• indicates that an individuals income can buy
  more of all goods when the price of one good
  declines, everything else held constant

22
Other Determinants of Demand

• Consumer equilibrium shows that nonprice
  determinants of demand have their effects through
  the MUs or the prices of other goods and
  services
• Example rising values of housing in downtown
  Tempe
• Coming town lake
• Close to the airport (what changed?)

23
Happy Valentines Day!

• Think about
• Elasticity of demand
• Consumer equilibrium
• Substitution and income effects
• Optimal SO search strategies
• See you on Monday!