Chapter 6 Professor Yuna Chen Consumer Choice and

Chapter 6 Professor Yuna Chen Consumer Choice and Demand © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1

6 -1 Utility Analysis • Utility – Sense of pleasure – satisfaction that comes from consumption – Subjective • Assumption – Taste are given – Tastes are relatively stable © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2

6 -1 a Taste and Preference • Total utility – Total satisfaction you derive from consumption • Of consuming a particular good • from all consumption • Marginal utility – Change in total utility from one-unit change in consumption © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3

Classroom Experiment Question: What is your dream car? Knock, knock… … © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4

6 -1 b Law of Diminishing Marginal Utility • Law of diminishing marginal utility – The more of a good consumed • The smaller the increase in total utility • Other things constant • Marginal utility from each additional unit – Declines as more is consumed • Total utility increases as long as marginal utility is positive © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5

6 -2 Measuring Utility 6 -2 a Units of utility – abstract concept rather than a concrete, observable quantity. – The "amount" of utility, therefore, are arbitrary, representing a relative value – Each person has a uniquely subjective utility scale © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 6

6 -2 b Utility Maximization without Scarcity • Goods are free if they are not scarce – Increase consumption as long as marginal utility is positive • Two free goods – Increase consumption of each good until the marginal utility of each is 0 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 7

Question Cookies and drinks were offered in a party. Valerie went to the party with her marginal utility of the first cookie being 50, the 2 nd one being 10, and the third being 0. For the drinks, her marginal utility of the first cup is 20, the 2 nd is 5, the 3 rd is -10. How many cookies and drinks did Valerie consume? Answer: Valerie must have eaten 2 cookies, and drank two cups of drinks. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 8

Case 1 Utility Maximization with Scarcity • Goods are not free (price of movie = $6, price of cookie = $3) • Income – limited (Income = $30) • How to maximize total utility? © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 9

Table 1. TU and MU Movies Cookies Q TU MU 0 0 --- 1 50 1 75 2 88 2 117 3 122 3 153 4 150 4 181 5 175 5 206 6 225 7 243 8 260 9 276 10 291 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10

Table 2 Choices Movie Cookie TU A 0 10 0+291 = 291 B 1 C 2 D 3 E 4 F 5 Choice _____ maximizes utility • Consumer equilibrium - There is no way to increase utility by reallocating the budget • Any change to other choices will reduce utility © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11

Case 1. Find MU per $ spent Movies Cookie Q MU MUm/Pm Q MU Muc/Pc 0 0 --- 1 50 1 75 2 38 2 42 3 34 5. 67 3 36 12 4 28 4. 67 4 28 9. 33 5 25 4. 17 5 25 8. 33 6 19 6. 33 7 18 6 8 17 5. 67 9 16 5. 33 10 15 5 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 12

6 -2 d Utility-Maximizing Conditions Utility-maximizing condition: – Last $ spent on each good yields the same marginal utility There is a typo in the formula in textbook page 90. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13

6 -2 d Utility-Maximizing Conditions In terms of utility theory, “equilibrium” in the real world means that households have spent their incomes in such a way that their overall satisfaction is maximized. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 14

6 -2 e MU and the Law of Demand Recall Case 1. Income = $30, Pm = $6, To max utility: Qm = 2 (Locate this in a diagram) Case 2. Income = $30, Pm = $3 Find the utility max Qm Qm = 5 (Locate this in a diagram) © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15

Example Demand for Movie Generated From Marginal Utility a Price of movie $6 b 3 D 0 2 5 Movie Relationship between a demand curve and utility maximization: © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16

Surprise!!! Demand curve is a result of utility maximization! © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17

Question Suppose the price of a chocolate bar is $2 and the price of a pack of chocolate chip cookies is $5. Assuming the consumer is at equilibrium, and the marginal utility of chocolate bar is 6, what is the marginal utility of chocolate chip cookies? Pb = $2 Pc = $5 MUb = 6 Muc = ? © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18

Answer • © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19

6 -3 a Consumer Surplus • Consumer surplus – The difference between what a consumer is willing and able to pay and what the consumer actually pays © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20

Example: I am willing and able to pay $10 for a movie ticket. At theater, the ticket costs me $6. What is my consumer surplus? CS = $10 - $6 = $4 Question. I am willing and able to pay $2 for a chocolate bar. The store is selling it at $4. What is my consumer surplus? - Will not buy it - CS = 0 - CS can’t be negative © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21

6 -3 b Market Demand &Consumer Surplus • Consumer surplus for the market – Amount consumers are willing to pay minus amount they pay – Net benefit for consumers – Economic welfare © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22

Example 2. How to calculate CS? • If the market price is $10, how much is CS? Price $30 $10 D 0 100 Books © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23

• Question. What happen to consumer surplus if price falls? • Consumer surplus increases. © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 24