1. Chapter 21 - Consumer Choice
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
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
Chapter 21 - Consumer Choice

2. Chapter 21 - Consumer Choice
Learning Objectives
Describe the substitution effect of a price change on the quantity demanded of a good or service
Understand how the real-income effect of a price change affects the quantity demanded a good or service
Evaluate why the price of diamonds is so much higher than the price of water even though people cannot survive long without water
Chapter 21 - Consumer Choice

3. Chapter 21 - Consumer Choice
Did You Know That...
There has been a proliferation of choices at U.S. grocery stores, which now stock an average of 40,000 items?
One way of deriving the law of demand involves an analysis of the logic of consumer choice in a world of limited resources?
In this chapter we discuss what is called utility analysis.
Chapter 21 - Consumer Choice

4. Chapter 21 - Consumer Choice
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 utility is measured
Chapter 21 - Consumer Choice

5. Utility Theory Marginal Utility
The change in total utility due to a one-unit change in the quantity of a good or service consumed
Marginal utility =
Change in total utility
Change in number of units consumed
Chapter 21 - Consumer Choice

6. Chapter 21 - Consumer Choice
Graphical Analysis
We can appreciate total and marginal utility by using graphical analysis.
Chapter 21 - Consumer Choice

7. Chapter 21 - Consumer Choice
Total and Marginal Utility of Downloading and Listening to Digital Music Albums
Chapter 21 - Consumer Choice

8. Chapter 21 - Consumer Choice
Total and Marginal Utility of Downloading and Listening to Digital Music Albums
Chapter 21 - Consumer Choice

9. Chapter 21 - Consumer Choice
Total and Marginal Utility of Downloading and Listening to Digital Music Albums
Chapter 21 - Consumer Choice

10. Chapter 21 - Consumer Choice
Total and Marginal Utility of Downloading and Listening to Digital Music Albums
Total utility is
maximized...
…where marginal
utility equals zero.
Chapter 21 - Consumer Choice

11. Chapter 21 - Consumer Choice
Graphical Analysis
Observations
Marginal utility falls as more is consumed.
Marginal utility equals zero when total utility is at its maximum.
Chapter 21 - Consumer Choice

12. The High Cost of Certain Sources of Negative Marginal Utility
Conventional wisdom says that it is impossible to put a price tag on happiness.
Economists usually attempt to attach dollar values to economic goods.
What is the amount of compensation required for economic “bads?”
Chapter 21 - Consumer Choice

13. 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.
Chapter 21 - Consumer Choice

14. Newspaper Vending Machines versus Candy 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 in the concept of diminishing marginal utility.
Chapter 21 - Consumer Choice

15. 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
Chapter 21 - Consumer Choice

16. Chapter 21 - Consumer Choice
Total and Marginal Utility from Consuming Music Album Downloads and Sandwiches on an Income of $26
Chapter 21 - Consumer Choice

17. Chapter 21 - Consumer Choice
Total and Marginal Utility from Consuming Music Album Downloads and Sandwiches on an Income of $26
Chapter 21 - Consumer Choice

18. Chapter 21 - Consumer Choice
Total and Marginal Utility from Consuming Music Album Downloads and Sandwiches on an Income of $26
Chapter 21 - Consumer Choice

19. Optimizing Consumption Choices
A consumer’s money income should be allocated so that the last dollar spent on each good purchased yields the same amount of marginal utility (when all income is spent), because this rule yields the largest possible total utility.
Chapter 21 - Consumer Choice

20. 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.
Chapter 21 - Consumer Choice

21. Optimizing Consumption Choices
A little math
The rule of equal marginal utilities per dollar spent
MU of good A
Price of good A =
MU of good B
Price of good B
MU of good Z
Price of good Z
...
Chapter 21 - Consumer Choice

22. How a Price Change Affects Consumer Optimum
Recall from Table 20-1 Income = $26
Qd = 4
MUd Pd
36.5 5 =
= 7.3
Qs = 2
MUs Ps 22 3
Chapter 21 - Consumer Choice

23. How a Price Change Affects Consumer Optimum
Assume Price of Music Falls to $4
Qd = 4
MUd Pd
36.5 4 =
= 9.125
Qs = 2
MUs Ps 22 3
= 7.3
Chapter 21 - Consumer Choice

24. How a Price Change Affects Consumer Optimum
Assume Price of Music Falls to $4
Result
Buy more downloads and MUd falls
Now
MUd Pd
>
MUs Ps
Chapter 21 - Consumer Choice

25. How a Price Change Affects Consumer Optimum
Consumption decisions are summarized in the law of demand
The amount purchased is inversely related to price.
A consumer’s response to a price change
At higher consumption rate, marginal utility falls.
Chapter 21 - Consumer Choice

26. Digital Music Download Prices and Marginal Utility
Chapter 21 - Consumer Choice

27. How a Price Change Affects Consumer Optimum
The Substitution Effect
The tendency of people to substitute cheaper commodities for more expensive commodities
Chapter 21 - Consumer Choice

28. How a Price Change Affects Consumer Optimum
The Principle of Substitution
Consumers and producers shift away from goods and resources that become priced relatively higher in favor of goods and resources that are now priced relatively lower.
Chapter 21 - Consumer Choice

29. How a Price Change Affects Consumer Optimum
Purchasing Power
The value of money for buying goods and services
Chapter 21 - Consumer Choice

30. How a Price Change Affects 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
When that price goes up (down), real income, or purchasing power, falls (increases).
Chapter 21 - Consumer Choice

31. The Demand Curve Revisited
Question
How is the demand curve derived?
Answer
By presuming income, tastes, expectations, and the price of related goods are not changing as the price of the good changes
Chapter 21 - Consumer Choice

32. 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.
Chapter 21 - Consumer Choice

33. The Diamond-Water Paradox
Chapter 21 - Consumer Choice

34. The Upside of Taking Off from a Less Convenient Airport
According to the principle of substitution, people shift away from consuming items that become priced relatively higher in favor of items that are now priced relatively lower.
In recent years, the principle of substitution has applied to the services offered by several major airports.
Many consumers of air travel are choosing to drive some distance before they depart to their ultimate destinations by plane.
Chapter 21 - Consumer Choice

35. The Upside of Taking Off from a Less Convenient Airport
Weighing relative marginal utilities and prices
Opting to avoid hassles that reduce marginal utility
Responding to price changes
Chapter 21 - Consumer Choice

36. Selected Substitute Airport Pairs in the United States
Chapter 21 - Consumer Choice

37. Summary Discussion of 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.
Law of diminishing marginal utility
Marginal utility ultimately declines as a person consumes more and more of a good or service.
Chapter 21 - Consumer Choice

38. Summary Discussion of Learning Objectives
The consumer optimum
Occurs when the marginal utility per dollar spent on the last unit consumed is equalized
The substitution effect of a price change
A person will substitute among goods by buying less of a good when its price increases.
Chapter 21 - Consumer Choice

39. Summary Discussion of Learning Objectives
The real-income effect of a price change
A price change affects the purchasing power of an individual’s available income.
Why the price of diamonds exceeds the price of water even though people cannot long survive without water
Marginal utility, not total utility, determines how much people are willing to pay.
Chapter 21 - Consumer Choice