1. Chapter 6 Consumer Choice and Demand © 2009 South-Western/Cengage Learning

2. 22 Utility Analysis Utility –What we gain from consumption Subjective Assumption –Tastes are given –Tastes are relatively stable

3. The Law of Diminishing Marginal Utility Total utility –total satisfaction Marginal utility –additional utility gained from consuming 1 additional unit of the good MU = ∆TU / ∆Q 3

4. Principle of Diminishing Marginal Utility As we consumer more of a good or service, the marginal utility declines. Notes on utility: –Cannot measure utility –Cannot compare utilities among consumers 4

5. Utility Maximization Without Scarcity Free good –consume up to the point where MU = 0 “all you can eat” buffets open bar 5

6. Utility Maximization With Scarcity Goods – not free –there exists a trade-off to consuming more of one good (in terms of other goods you cannot consume) We need to compare the value to the individual of purchasing and consuming one more unit of a good with the value of other opportunities 6

7. Utility-Maximizing Conditions Equilibrium –There is no way to increase utility by reallocating the budget –Last $ spent on each good yields the same marginal utility –Higher-priced goods must yield more Marginal Utility than lower-price goods 7

8. Consumer Equilibrium MU A /P A = MU B /P B = MU C /P C = … for all purchased goods Consumer reaches greatest utility overall when the utility per dollar spent is equal for all purchased goods. 8

9. Individual vs Market Demand PriceQ Dick Q Jane Q Sally Q Market 102103 84228 663514 484921 21051530 9 The market demand is the sum of the individual consumer’s demands at every price Horizontal summation of demand curves

10. Consumer Surplus Value of a good purchased must at least equal the P what is maximum consumer is willing to pay? D curve shows marginal valuation Consumer surplus –difference between what the consumer is willing to pay and the market price –graphically area under D, above P 10

11. Market D and Consumer Surplus Market D curve –Horizontal sum of individual D curves –Total quantity demanded, per period, by all consumers, at various prices Consumer surplus for the market –Amount consumers are willing to pay minus amount they pay –Net benefit for consumers –Economic welfare 11