MICROECONOMICS: Theory & Applications Chapter 5 Using Consumer Choice Theory By Edgar K. Browning & Mark A. Zupan John Wiley & Sons, Inc. 9th Edition, copyright 2006 PowerPoint prepared by Della L. Sue, Marist College

Learning Objectives Determine how an excise subsidy affects consumer welfare and why it results in a deadweight loss. Examine how the public provision of a certain quantity of a good such as education may lead to less consumption of the good. Analyze how a voucher program would affect the quantity of educational services chosen by parents for their children. (continued) John Wiley & Sons, Inc. Copyright 2006

Learning Objectives (continued) Explore the impact of per-bag charges versus a fixed annual fee on the amount of trash generated by a community, recycling, and household welfare. Develop an intertemporal model that illuminates the consumer’s choice to save or borrow and shows how changes in endowment and the interest rate affect that choice. Understand how the theory of consumer choice can explain what types of financial assets an individual intent on saving for the future should purchase, or invest in. John Wiley & Sons, Inc. Copyright 2006

Excise Subsidies, Health Care, and Consumer Welfare Excise subsidy – a form of subsidy in which the government pays part of the per-unit price of a good and allows consumers to purchase as many units as desired at the subsidized price Lump-sum transfer – a form of subsidy in which the government gives the consumer a cash grant to be spent in any way the recipient wants John Wiley & Sons, Inc. Copyright 2006

Excise Versus Lump-Sum Subsidy [Figure 5.1] John Wiley & Sons, Inc. Copyright 2006

Using the Consumer Surplus Approach Deadweight loss – a measure of the loss in well-being resulting (in this case) from the use of an excise subsidy Figure 5.2 John Wiley & Sons, Inc. Copyright 2006

Subsidizing Consumption The government has two ways to subsidize consumption: Reduce the price Provide a particular quantity of the good or service at a price below the market price Examples: Education Garbage disposal The Consumer’s Choice to Save or Borrow Investor Choice John Wiley & Sons, Inc. Copyright 2006

Public Schools and the Voucher Proposal [Figure 5.3] John Wiley & Sons, Inc. Copyright 2006

Consumer Choice: Garbage Disposal [Figure 5.4] John Wiley & Sons, Inc. Copyright 2006

Trash Disposal: The Bag System [Figure 5.5] John Wiley & Sons, Inc. Copyright 2006

The Consumer’s Choice to Save or Borrow [Figure 5.6] John Wiley & Sons, Inc. Copyright 2006

Effect of a Change in Endowment on Saving or Borrowing [Figure 5.7] John Wiley & Sons, Inc. Copyright 2006

Effect of a Change in Interest Rate on Saving or Borrowing [Figure 5 John Wiley & Sons, Inc. Copyright 2006

Investor Choice - Terminology Expected return – the summed value of each possible rate of return weighted by its probability Expected utility – the summed value of each possible utility weighted by its probability (Continued) John Wiley & Sons, Inc. Copyright 2006

Investor Choice – Terminology (continued) Risk averse – a state of preferring a certain return to an uncertain prospect that generates the same expected return Risk neutral – a state of deriving the same utility from a certain return as from an uncertain prospect generating the same expected return Risk loving – a state of deriving less utility from a certain return than from an uncertain prospect generating the same expected return Insurance – an arrangement by which the consumer pays a premium in return for the promise that the insurer will provide compensation for losses due to misfortune Diversification – investing a given amount of resources in numerous independent projects instead of a single project in order to minimize exposure to risk John Wiley & Sons, Inc. Copyright 2006

The Return-Risk Tradeoff [Figure 5.10] John Wiley & Sons, Inc. Copyright 2006

Investor Preferences and Risk [Figure 5.12] John Wiley & Sons, Inc. Copyright 2006

Minimizing Exposure to Risk [Figure 5.13] John Wiley & Sons, Inc. Copyright 2006

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