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