1. Chapter 10 Consumer Choice

2. 1. What is behind the law of demand? The law of demand can be explained in terms of the concept of utility theory. 2. Utility (TU) - The enjoyment or satisfaction that people derive from consuming goods and services. Marginal utility (MU) - The additional utility a person derives from consuming one additional unit of a good or service. MU =ΔTU/ ΔQ

3. Consumer Choice Law of diminishing marginal utility (LDMU) suggests that c onsumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time. Utils are units of utility measure 3. Example (TU, MU, LDMU) Q (Pizza slices) TU MU=ΔTU/ ΔQ 0 0 - 1 20 20 2 36 16 3 46 10 4 52 6 5 54 2 6 54 0 Q TU MU Q

4. Consumer Choice 4. How does the marginal utility change as we consume more of a good? It decreases-=>LDMU Each additional unit of a good, or service yields lower additional utility (i.e., LDMU) 5. LDMU- refers to the notion that the consumption of successive units of a good gives us reduced satisfaction 6. Some statements about Marginal Utility I couldn’t eat any more bite of pizza (MU=0) I’ll never get tired of eating your cooking (MU is rising). The last drop tastes as good as the first (MU is constant). I wouldn’t eat broccoli even if you paid me (MU is negative)

5. Consumer Choice 7. Given U=f(X, Y), the limited budget, and Px and Py, find the units of X and Y which maximize the consumers total utility (U). How should consumers allocate their limited income among various goods and services? 8. They should allocate in such a way that the MU per dollar cost of different goods and services, i. e., the MU/dollar cost of one good is equal to the MU/dollar cost of all other goods. For goods X and Y, the utility maximizing rule is: MU X /P X =MU Y /P Y

6. Consumer Choice 9. Budget constraint - The limited amount of income available to consumers to spend on goods and services. Suppose an individual has $10 to spend on pizza slices and beer which cost $2.00, respectively. $10 = 2X + 2Y. The consumer has to make the decision of (choose) how much to spend on X and Y, given the MU X and MU Y and the prices of X and Y. Recall the utility maximizing rule: MU X /P X =MU Y /P Y ( See back of the handout)

7. Consumer Choice Demand for Beer Q P 3 $2 $1 4 D