consumer choice utility consumer surplus budget constraints indifference curves utility ...

Consumer ChoiceConsumer Choice

UtilityConsumer surplusBudget Constraints Indifference Curves

UtilityConsumer surplusBudget Constraints Indifference Curves

I. Utility Analysiswhat is utility?

benefit you get from consuming a good determined by your tastes/preferences

(assume these are stable)

total utility (TU) total benefit from consuming goodexample

total benefit from 3 cookies

TU increases as consumption increases, to a point

<TU 2 cookies TU 3 cookies

marginal utility (MU)change in TU from

consuming one more of a goodexample

how much MORE utility from

an additional pack of gum?

change in TU from0 to 1 cookie

change in TU from1 cookie to 2 cookies

MU of 1st cookie

MU of 2nd cookie

=

=

0

diminishing marginal utilityMU falls as consumption risesget sick of cookies

MU of 1st cookie

> MU of 2nd cookie

0

TU

cookie

TU rises at slower and slower rate

as MU declines

MU

cookie

How to maximize TU?use available budgetequalize MU/$ across goodsHuh?

chose combination of cookies and milk where

price of cookies price of milk

MU cookies=

MU milk

why?chose combo of 6 cookies, 1 milksuppose MU/$1 of cookies = 4,

MU/$1 of milk = 15by consuming fewer cookies, more

milk…

I would add more to my TU

TU vs. MUDiamond-Water paradox$10,000

one carat diamond 5 million gallons of tap water

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

MU and demandMU declines as consumption riseswilling to pay less for each additional

unit downward sloping demand

example : pizza

P

Q

D

$10

4 pizzas

for 4th pizzawilling to pay $10

for 2nd pizza$15

2 pizza

willing to pay $15

II. Consumer Surplusdifference between what you pay for a

good,

any what you are WILLING to pay for a good

P

Q

D

$10

my demand curve

$12

3

my consumer surplus

P

Q

D

$10

10,000

total consumer surplus

area between Dand price of pizza

III. The Budget Linegiven:

consumer’s budget prices

draw a line representing choicesconsumption possibilities

example2 goods: milk & cookiesbottle of milk = $1cookie = $.50daily budget = $4

possible combinations

cookies milk

02468

43210

budget line

milk

cookies

8

4

2

6

0421 3

budget line

milk

cookies

8

4

2

6

0421 3

Affordable

Unaffordable

what if prices change?changes slope of budget linesuppose cookies = $1

budget line

milk

cookies

8

4

2

6

0421 3

cookie = $.50

cookie = $1

what if budget changesbudget line shiftssuppose budget = $5

milk

cookies

budget = $4

budget = $58

4

2

6

0

10

421 3 5

IV. Indifference Curves (appendix)alternative way to show utilitycurve shows combo of goods

that deliver same total utility

example: milk and cookies

milk

8

4

2

6

0421 3

cookies

Indifference curve

Every point on curve has same total utility

TU is higher as curve shifts right

milk

cookies

higher TU

lower TU

consumer equilibriummaximize TUstay on budget

consumer equilibrium

cookies

8

milk4

4

2

best affordable point

consumer equilibrium

cookies

8

milk4

4

2

best affordable point

sum it upconsumer decisions based on

preferences budget constraint

consumer decisions made at the margin marginal benefit of one more compared to price of one more