Chapter 10 Consumer Choice

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

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 Q TU MU Q

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)

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

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)

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