1. Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program
CHAPTER5 . CONSUMER CHOICE
Zoubida SAMLAL - MBA , CFA Member, PHD candidate for HBS program

2. Consumer Choice Utility Consumer surplus Budget Constraints
Indifference Curves

3. I. Utility Analysis what is utility?
benefit you get from consuming a good
determined by your tastes/preferences
(assume these are stable)

4. total utility (TU) total benefit from consuming good example
total benefit from 3 cookies

5. < TU increases as consumption increases, to a point TU 2 cookies

6. marginal utility (MU) change in TU from consuming one more of a good
example
how much MORE utility from
an additional pack of gum?

7. = = change in TU from 0 to 1 cookie MU of 1st cookie change in TU from
change in TU from
1 cookie to 2 cookies =
MU of 2nd cookie

8. diminishing marginal utility
MU falls as consumption rises
get sick of cookies

9. MU of 1st cookie
>
MU of 2nd cookie

10. TU rises at slower and slower rate
cookie MU
cookie
as MU declines

11. How to maximize TU? use available budget equalize MU/$ across goods
Huh?

12. MU cookies = MU milk price of cookies price of milk
chose combination of cookies and milk where
MU cookies =
MU milk
price of cookies
price of milk

13. why? chose combo of 6 cookies, 1 milk suppose MU/$1 of cookies = 4,
MU/$1 of milk = 15
by consuming fewer cookies, more milk…
I would add more to my TU

14. TU vs. MU Diamond-Water paradox $10,000 one carat diamond
5 million gallons of tap water

15. why? TU of water is greater than TU of diamonds
water is essential for life
BUT water is abundant, diamonds are rarer
MU of last diamond is higher
MU determines value

16. MU and demand MU declines as consumption rises
willing to pay less for each additional unit
downward sloping demand

17. example : pizza P willing to pay $15 for 2nd pizza willing to pay $10Q
willing to pay $15 D
for 2nd pizza
$15
2 pizza
$10
4 pizzas
willing to pay $10
for 4th pizza

18. II. Consumer Surplus difference between what you pay for a good,
any what you are WILLING to pay for a good

19. example market price pizza = $10
my marginal value of 3rd pizza this week = $12
my consumer surplus = $2

20. my demand curve P Q D
$12 3
my consumer surplus
$10

21. P D Q total consumer surplus $10 area between D and price of pizza
10,000
area between D
and price of pizza

22. III. The Budget Line given: draw a line representing choices
consumer’s budget
prices
draw a line representing choices
consumption possibilities

23. example 2 goods: milk & cookies bottle of milk = $1 cookie = $.50
daily budget = $4

24. possible combinations
cookies
milk 2 4 6 8 4 3 2 1

25. budget line
cookies 8 4 2 6
milk 4 2 1 3

26. budget line
cookies 8 4 2 6
Unaffordable
Affordable
milk 4 2 1 3

27. what if prices change? changes slope of budget line
suppose cookies = $1

28. budget line
cookie = $.50
cookies 8 4 2 6
cookie = $1
milk 4 2 1 3

29. what if budget changes
budget line shifts
suppose budget = $5

30. 8 4 2 6 10
cookies
budget = $5
budget = $4
milk 4 2 1 3 5

31. IV. Indifference Curves
(appendix)
alternative way to show utility
curve shows combo of goods
that deliver same total utility

32. example: milk and cookies
Every point on curve has same total utility 8 4 2 6
Indifference curve
milk 4 2 1 3

33. TU is higher as curve shifts right
cookies
higher TU
lower TU
milk

34. consumer equilibrium
maximize TU
stay on budget

35. consumer equilibrium
cookies 8
best affordable point 4 2
milk 4

36. consumer equilibrium
cookies 8
best affordable point 4 2
milk 4

37. sum it up consumer decisions based on
preferences
budget constraint
consumer decisions made at the margin
marginal benefit of one more
compared to price of one more