1. Utility Analysis Chapter 21 & 21 Appendix
Understanding consumer purchases!
Understanding Demand!!

2. Understanding Demand! Why do demand curves slope down?
1. Income effect – the effect a price change has on a consumers real income.
- the lower price gives the consumer more purchasing power to buy other goods or more of the same good.
2. Substitution effect – a lower price increases the relative attractiveness of a product.
Overall the two effects make a consumer willing and able to buy more of a specific good at a lower price.

3. Understanding Demand!
3. Law of diminishing marginal utility – the satisfaction we receive typically declines as we consume more of it.
We will only buy additional units of a product if the price falls.
Utility, however, is very subjective. What one consumer values another may not.

4. Panty hose a 5 by former economist Travis?
Would these two AP Econ students rate Pizza the same?
Would these two AP Econ students rate soap the same?
Would these two AP Econ students rate panty hose the same?
Panty hose a 5 by former economist Travis?

5. Consumer Surplus
If an ice cream cone costs $1.50, but Kelly would pay $2.00 for the ice cream cone than Kelly’s consumer surplus is $0.50
If a Hockey Stick costs 24.50, and Kris would pay $30.00 for a Hockey Stick than his consumer surplus is $5.50.
They would feel good about their lucky purchases! All have received some UTILITY!

6. Consumer Surplus
If a slice of pizza costs $1.50, but Adam would pay $2.00 for the slice of pizza than Adam’s consumer surplus is $0.50.
If a new pair of football shoes costs $64.50, and Andy would pay $70.00 for a pair of football shoes than his consumer surplus is $5.50.
They would feel good about their lucky purchases! Both have received some UTILITY!

7. Total Consumer Surplus
Price
$40
At a price of $30!
$30
Total Cosumer Surplus
$20
$10
Quantity

8. Consumer & Producer Surplus & Dead Weight Loss
Consumer surplus D Q

9. Consumer & Producer Surplus & Dead Weight LossQ

10. Consumer & Producer Surplus & Dead Weight Loss
S + Tax
Consumer
Surplus S P2
Tax
Revenue
Dead Weight Loss P1
Producer
Surplus D Q Q2 Q1

11. Dead Weight Loss P S P2
Price Floor P1 D Q Q2 Q1

12. Utility The want satisfying power of a good or service!
Utility can be measured in $$$ but most people don’t think about a purchase’s money value! They think about how good they feel about their purchase!

13. Utils
Utils can subjectively measure the value a consumer places upon a purchase.
If 1 Util is low value and 10 Utils are high value, what’s your value of a mythical item say a “Krobrogel!”
We measure utility by using Utils for illustrative purposes.

14. GHS

15. Assigning value by Utils
Allows for subjectivity
Allows for individuality
Removes the need to be concerned with money or price initially
A way to measure the satisfaction of consumers.
A way to evaluate consumers purchasing decisions.

16. Assigning value by Utils
Marginal Utility: The individual increment of value. The value received from consuming one more good or service.
MU = Change in TU/ Change in Quantity
Total Utility:The sum of the marginal utilities received when goods or services are consumed or purchased.
Utility is Subjective
Q1 = 10 MU: TU = 10 Utils
Q2 = 8 MU: TU = 18 Utils

17. Irrational Consumption
Rational vs. Irrational Consumption
As we consume or purchase more our marginal utility declines while our total utility rises as long as we remain rational. This is why demand curves slope down!!!
Irrational Consumption
Most consumers are rational!
Some consumers are not!!!

18. Consumer Surplus in Total
MU >= P P S
To Maximize Consumer
Surplus a Rational
Consumer Purchases as
Long as MU >= P P D Q Q

19. Rational Consumers Follow the Law of Diminishing Marginal Utility
As more of a product is consumed, acquired, or purchased, its individual value to you falls, but your total value rises.
You eat faster at the beginning of a meal than at the end.

20. Utility Table Quantity Marginal Utils Total Utils 1 2 10 8 18 3 4 6 241 2 10 8 18 3 4 6 24 28 5 30

21. Marginal Utility Falls while Total Utility Rises.
Quantity
Marginal Utils
Total Utils 1 2 10 8 18 3 4 6 24 28 5 30
Marginal Utility Falls while Total Utility Rises.

22. Choosing between Products?
How do consumers allocate their incomes among various products?

23. The Law of Equal Marginal Utility!
Rational Consumers and Wage Earners quickly learn to determine value per dollar.
Rational Consumers purchase to gain the highest “Value per Dollar”.
Value can be expressed using utility!
The value of a good or service about to be purchased is a goods MU – Marginal Utility.

24. Making a purchase???? Big Mac or Pizza
If the MU of a Big Mac is 20 and its price is $2, than its value per dollar or MU/P is 10.
If the MU of a Pan Supreme is 30 and its price is $10, than its value per dollar or MU/P is 3.

25. Why are more Big Mac Purchased than Pizzas?
Consumer may like pizza more than Big Macs, but rational consumers also understand the value of money.
MU/P = 10
MU/P = 3
Rational consumers purchase where MU/P is greatest!

26. The Law of Equal Marginal Utility or the Final Purchase Rule or the Utility Maximization Rule
Consumers will maximize Total Utility when final purchases give the same MU/P’s.
MU/P Big Mac = 4
MU/P Fries = 4
MU/P Shake = 4

27. Case Studies on Utility AP Activity #11
MU = ^TU/^Q
Max Consumer Surplus Rule: Buy as long as MU >= P
Choosing be between products? Buy where MU/P is greatest
Multiple Purchase Rule to Maximum satisfaction: MUx/Px = Muy/Py…Mun/Pn
May
11th
2006

29. Quantity of Cheeseburgers
PPC – Pizza and cheeseburgers 12 10 8 6 4 2
This consumer could purchase
2.5 Cheeseburgers or 5 Slices of
Pizza with a budget of $5.00
Quantity of Cheeseburgers
Price at $2.00
The red curve is an Indifference
Curve and the dot is at the point
of tangency or actual purchase
amounts! We’ll learn more about
that later on!
Quantity of Pizza
Priced at 1.00

30. What did the consumer purchase?
3 Slices of Pizza
A 4th slice of pizza or a cheeseburger!
Why?
Because rational consumers purchase where their MU/P is highest and their total utility is highest.
MU/P is value per dollar

31. Case Study #2 Budgeted Income $9.00 Double Cheeseburger costing $2.00
Budgeted Income $9.00
Double Cheeseburger costing $2.00
Quantity
Marginal Utility
Total Utility
Marginal Utility/Dollar
Purchase 1 14 7
3 or 4 2 12 26 6
5 or 6 3 10 36 5 4 8 44 50
Pizza by the Slice costing $1.00 9 17 24 30 35

32. Quantity of Cheeseburgers
PPC – Pizza and cheeseburgers 12 10 8 6 4 2
This consumer could purchase
4.5 Cheeseburgers or 9 Slices of
Pizza with a budget of $9.00
Quantity of Cheeseburgers
Price at $2.00
The red curve is an Indifference
Curve and the dot is at the point
of tangency or actual purchase
amounts! We’ll learn more about
that later on!
Quantity of Pizza
Priced at 1.00

33. What did the consumer purchase?
5 Slices of Pizza
2 Cheeseburgers
Why?
Because rational consumers purchase where their MU/P is highest!
MU/P is value per dollar

35. Quantity of Cheeseburgers
PPC – Pizza and cheeseburgers 12 10 8 6 4 2
This consumer could purchase
4 Cheeseburgers or 8 Slices of
Pizza with a budget of $8.00
Quantity of Cheeseburgers
Price at $2.00
The red curve is an Indifference
Curve and the dot is at the point
of tangency or actual purchase
amounts! We’ll learn more about
that later on!
Quantity of Pizza
Priced at 1.00

36. What did the consumer purchase?
3 Slices of Pizza
2 Cheeseburger
A 4th slice of pizza could be bought but not a third cheeseburger. The consumer might save $1.00
Why?
Because rational consumers purchase where their MU/P is highest!
MU/P is value per dollar

38. Quantity of Cheeseburgers
PPC – Pizza and cheeseburgers 12 10 8 6 4 2
This consumer could purchase
4.5 Cheeseburgers or 9 Slices of
Pizza with a budget of $9.00
Quantity of Cheeseburgers
Price at $2.00
The red curve is an Indifference
Curve and the dot is at the point
of tangency or actual purchase
amounts! We’ll learn more about
that later on!
Quantity of Pizza
Priced at 1.00

39. What did the consumer purchase?
3 Slices of Pizza
3 Cheeseburgers
Why?
Because rational consumers purchase where their MU/P is highest!
MU/P is value per dollar

40. 12 10 8 6 4 2
What is this???
PPC – Constant Cost Graph

41. Output! PPC – Constant Cost Graph What if the Axis's12 10 8 6 4 2
What if the Axis's
Were labeled wheat & oil?
Quantity of Wheat
In tons
What is this now an
Output or Input PPC?
Quantity of Oil
In millions of barrels
Output!

42. PPC – Constant Cost Graph of
Outputs 12 10 8 6 4 2
Quantity of Wheat
In tons
Quantity of Oil
In millions of barrels

43. PPC – What if costs of an Output change? Quantity of Wheat In tons12 10 8 6 4 2
Quantity of Wheat
In tons
Quantity of Oil
In millions of barrels

44. Quantity of Wheat In tons Quantity of Oil In millions of barrels
PPC – What happens if cost decrease? 12 10 8 6 4 2
Quantity of Wheat
In tons
Quantity of Oil
In millions of barrels

45. Quantity of Wheat In tons Quantity of Oil In millions of barrels
PPC – What happens if cost decreases
for Oil only? 12 10 8 6 4 2
Quantity of Wheat
In tons
Quantity of Oil
In millions of barrels

46. PPC – What if costs increase?12 10 8 6 4 2
Quantity of Wheat
In tons
Quantity of Oil
In millions of barrels

47. PPC – What if costs increase for only Wheat?12 10 8 6 4 2
Quantity of Wheat
In tons
Quantity of Oil
In millions of barrels

48. What if this is a Consumer and these are products???12 10 8 6 4 2
This is it still a PPC Curve!
If product costs are constant,
what limits purchase amounts?
Quantity of A DI
Quantity of B
Introducing a Special PPC – The Budget Line!

49. A Consumer’s Budget Line
From a Business
Perspective a
Customer’s
Budget Line! 12 10 8 6 4 2
What sets the limits
on a Budget Line?
Quantity of A
Quantity of B
Schill 2003

50. A Customer’s Budget Line
What sets the limits
on a Budget Line? 12 10 8 6 4 2
The Prices of
Good A & Good B
Consumer/Customer
Disposable Income
(Unattainable)
Quantity of A
Price $1.50
DI = $12
(Attainable)
Quantity of B
Price $1.00
Schill 2003

51. A Customer’s/Consumer’s Budget Line12 10 8 6 4 2
DI = $12
(Unattainable)
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures
Quantity of A
8 0 $12
DI = $12
(Attainable)
Quantity of B
Schill 2003

52. A Customer’s Budget Line12 10 8 6 4 2
What if DI rises to $15?
(Unattainable)
Quantity of A
Price $1.50
(Attainable)
DI = $12
Quantity of B
Price $1.00
Schill 2003

53. A Customer’s Budget Line
What if the price of Good A
Falls to $1.00??? 12 10 8 6 4 2
DI = $12
(Unattainable)
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures
Quantity of A
8 0 $12
(Attainable)
Quantity of B
Schill 2003

54. A Customer’s Budget Line12 10 8 6 4 2
DI = $12
(Unattainable)
Units of A
Price $1.00
Units of B
Price $1.00
Total
Expenditures
Quantity of A
$12
(Attainable)
Quantity of B
More of Good A can be purchased!
Schill 2003

55. A Customer’s Budget Line
What if prices rise? 12 10 8 6 4 2
DI = $12
(Unattainable)
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures
Quantity of A
8 0 $12
(Attainable)
Quantity of B
Schill 2003

56. A Customer’s Budget Line12 10 8 6 4 2
DI = $12
(Unattainable)
Units of A
Price $3.00
Units of B
Price $2.00
Total
Expenditures
Quantity of A
(Attainable)
Quantity of B
Schill 2003

57. A Customer’s Budget Line12 10 8 6 4 2
DI = $12
(Unattainable)
Units of A
Price $3.00
Units of B
Price $2.00
Total
Expenditures
Quantity of A
(Attainable)
Quantity of B
Schill 2003

58. a change in the quantity
A Customer’s Budget Line
Price changes cause
a change in the quantity
demanded of the items 12 10 8 6 4 2
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures
8 0 $12
(Unattainable)
Quantity of A
(Attainable)
Quantity of B

59. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12
Quantity of A
An Indifference Schedule
Combination
Units of A
Units of B j
Quantity of B

60. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12 k
Quantity of A
An Indifference Schedule
Combination
Units of A
Units of B j k
Quantity of B

61. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12 k
Quantity of A l
An Indifference Schedule
Combination
Units of A
Units of B j k l
Quantity of B

62. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12 k
Quantity of A l m
An Indifference Schedule
Combination
Units of A
Units of B j k l m
Quantity of B

63. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12 k
Quantity of A l m
An Indifference Schedule I3
Combination
Units of A
Units of B j k l m
Quantity of B

64. All Choices Equally Pleasing!
A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12 k
Quantity of A l m
An Indifference Schedule I3
Combination
Units of A
Units of B j k l m
All Choices Equally Pleasing!

65. A Customer’s Product Indifference
The slope
represents
the marginal
rate of substi-
tution, (MRS)
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12 k
Quantity of A l m
An Indifference Schedule I3
Combination
Units of A
Units of B I1 j k l m
Quantity of B
All combinations are both equally pleasing
and at each point the MU’s of A & B are equal

66. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2
8 0 $12
If the consumer
had greater income,
more of either or
both products could
be purchased
Quantity of A
An Indifference Schedule
Combination
Units of A
Units of B j k l m
Quantity of B

67. A higher combination of choices will be preferred
A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2 j
8 0 $12
A higher
combination
of choices will
be preferred k
Quantity of A l m
An Indifference Schedule I3
Combination
Units of A
Units of B I2 I1 j k l m
Quantity of B

68. A Customer’s Product Indifference
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2
8 0 $12
Quantity of A
A family of all
such expressions of
indifference can be
developed for every
level of income
An Indifference Schedule I4 I3
Combination
Units of A
Units of B I2 I1 j k l m
Quantity of B

69. as an indifference map -
A Customer’s Product Indifference
Happiest on I4
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2
8 0 $12
Quantity of A
This is known
as an indifference map -
Higher levels are
always preferred to
lower levels
An Indifference Schedule I4 I3
Combination
Units of A
Units of B I2 I1 j k l m
Quantity of B

70. A Customer’s Equilibrium Positionj
Units of A
Price $1.50
Units of B
Price $1.00
Total
Expenditures 12 10 8 6 4 2
Equilibrium
occurs when
the consumer
selects the
combination
which reaches
the highest
attainable
indifference
curve
(Unattainable)
8 0 $12 k
Quantity of A l m
An Indifference Schedule I4
(Attainable) I3
Combination
Units of A
Units of B I2 I1 j k l m
Quantity of B

71. A Customer’s Equilibrium Position
What happens
if the price of B
increases to $1.50
Equilibrium
at $1 price
for good B
4 units of A and
6 units of good B 12 10 8 6 4 2
Quantity of A I3 I1
Quantity of B

72. A Customer’s Equilibrium Position
What happens
if the price of B
increases to $1.50
Equilibrium
at $1 price
for good B
4 units of A and
6 units of good B 12 10 8 6 4 2
PriceB
QuantityB
$1.00 6
Quantity of A I3 I1
Quantity of B

73. A Customer’s Equilibrium Position
The budget line
rotates reflecting
the reduction in
the quantity of B
units which is
attainable
What happens
if the price of B
increases to $1.50 12 10 8 6 4 2
PriceB
QuantityB
$1.00
1.50 6 3
Quantity of A I3 I1
Quantity of B

74. A Customer’s Equilibrium Position
The budget line
rotates reflecting
the reduction in
the quantity of B
units which is
attainable
What happens
if the price of B
increases to $1.50 12 10 8 6 4 2
PriceB
QuantityB
$1.00
1.50 6 3
Quantity of A
By recording the
various quantities
demanded at the
various prices yields
the Demand schedule I3 I1
Quantity of B

75. Deriving the Demand Curve12 10 8 6 4 2
As price of B rose from
$1.00 to $1.50 Q
Fell from 6 to 3!
$1.50
1.00
.50
Wow!
Price of B
Quantity of A I3 I1
Quantity of B
Quantity of B
As the price rose from $1.00 to $1.50 the budget line shifted in
and the consumer shifted from I2 to I1 choosing 3 units of good B
instead of 6!

76. The End! Prepare for a 60 Question Test!