Consumer Choice Consumer Surplus Producer Surplus and Deadweight

Consumer Choice Consumer Surplus, Producer Surplus and Deadweight Loss

Utility �Utility looks at the satisfaction that a consumer receives from a good. �Total utility is the satisfaction that a person gets from consuming a specific quantity of a good or service �Marginal utility is the additional utility that one receives from the consumption of one more unit of that good.

Law of Diminishing Utility �The added satisfaction declines as consumers consume additional units of a product �This helps to explain why the demand curve is downward sloping

Consumer Behavior �Classical Economists believe that people are fundamentally rational �Thus they believe that: � 1. Rational- people try to maximize satisfaction � 2. Preferences- each consumer has specific preferences � 3. Budget Constraint- each consumer has a fixed and limited budget � 4. Prices- all goods have prices

Utility Maximizing Rule �Consumers will allocate money so that the last dollar spent on each product will yield the same amount of marginal utility. �Marginal Utility Product A/Price of Product A= �Marginal Utility Product B/Price Product B

Creemes Quantity of Creemes Marginal Utility ($’s) Total Utility ($’s) 1 1. 5 2 1. 0 2. 5 3 0. 7 3. 2 4 0. 4 3. 6 5 0. 2 3. 8 6 0. 05 3. 85

Utility �From the previous chart, we can create a graph of the total utility curve and the marginal utility. �We can also construct the demand curve for this consumer.

Consumer and Producer Surplus �Consumer Surplus is the value that the consumer receives from a good above the price for that good. In our previous example, if the price of creemes was $0. 50, the first creeme purchased would result in a consumer surplus of $1. 00. �Producer Surplus is the difference between the amount a seller receives for a good and the minimum amount that they would sell the good for. �Draw graphs for each of these.

Deadweight Loss �This is the loss to society as a result of the government adding price controls and taxes. �Examples of price controls: minimum wage; price controls on apartments in NYC �Examples of taxes: rooms and meals taxes; sales taxes; excise taxes (tax imposed at the producer level on a specific good-example is gas taxes). Taxes can be imposed on either the buyer or the seller of the good. �Draw graph showing the deadweight loss can be found on pages 144 -147 of The Princeton Review.

Conclusions/Observations �Utility: The sum of consumer and producer surplus is maximized at free market equilibrium �Diminishing marginal utility occurs when total utility increases at a decreasing rate �Total utility is maximized when marginal utility is 0. See graphs on page 85 of Princeton Review � Elasticity: When price and total revenue move in opposite directions, demand is elastic � Supply is more elastic in the long run than in the short run

Income Effect �The lower price of a good will increase the purchasing power of a buyers income, which allows them to buy more of the good. A higher price has the opposite effect. This represents a change in consumption patterns due to a change in purchasing power. This can happen when income changes or when the price of a good changes relative to other goods.

Substitution Effect �When the price of a good decreases, the buyer has an incentive to substitute what is now a less expensive good for other products that are now relatively more expensive.

Example �As the price of chicken goes down: �You will buy more chicken as you have relatively more income (Income Effect) �You will substitute it for beef and pork, thus buying more chicken (Substitution Effect)

Information �Deadweight Loss in Economics (handout) �Essential graphs for AP Microeconomics (handout) � AP Economics Macro and Micro Exams 2018 Editionpages 84 -100 (this reviews Consumer Choice, Elasticity and Deadweight Loss)