Introduction. Learning Objectives. Learning Objectives. Economics Today Twelfth Edition. Chapter 19 Consumer Choice

Introduction Roger LeRoy Miller Economics Today Twelfth Edition About one-third of U.S. federal income tax returns are filed electronically. Chapt...
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Introduction

Roger LeRoy Miller

Economics Today Twelfth Edition

About one-third of U.S. federal income tax returns are filed electronically.

Chapter 19 Consumer Choice

What factors determine the choice of software for those who prepare their own return and transmit it to the IRS electronically?

Copyright © 2004 Pearson Addison Wesley. All rights reserved.

Slide 19-2

Learning Objectives

Learning Objectives

 Distinguish between total utility and marginal utility  Discuss why marginal utility at first rises but ultimately tends to decline as a person consumes more of a good or service

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 Explain why an individual’s optimal choice of how much to consume of each good or service entails equalizing the marginal utility per dollar spent across all goods and services  Describe the substitution effect of a price change on the quantity demanded of a good or service Slide 19-4

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Learning Objectives

Chapter Outline

 Understand how the real-income effect of a price change affects the quantity of a good or service demanded  Evaluate why the price of diamonds is so much higher than the price of water even though people cannot survive long without water

    

Utility Theory Graphic Analysis Diminishing Marginal Utility Optimizing Consumption Choices How a Price Change Affects Consumer Optimum  The Demand Curve Revisited

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Slide 19-6

Did You Know That...

Utility Theory

 Online shoppers do not spend much time comparing prices of the same items at other Web sites?  A reduction in overall time spent locating and selecting an item reduces its cost?

 Utility – The want-satisfying power of a good or service

 Utility Analysis – The analysis of consumer decision making based on utility maximization

 Util – A representative unit by which utility is measured

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Slide 19-8

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Total and Marginal Utility of Watching Videos

Utility Theory  Marginal Utility – The change in total utility due to a one-unit change in the quantity of a good or service consumed

Marginal utility =

change in total utility change in number of units consumed

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Figure 19-1, Panel (a)

Slide 19-10

Total and Marginal Utility of Watching Videos

Graphic Analysis  A graph can be used to display the values displayed in the table to better see their relationships.

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Figure 19-1, Panel (b)

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Total and Marginal Utility of Watching Videos

Total and Marginal Utility of Watching Videos Total utility is maximized...

20

10

16 Marginal Utility (utils per week)

Total Utility (utils per week)

18

14 12 10 8 6 4 2 0

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Total and Marginal Utility of Watching Videos

6 4 2 0 -2

1

-4 1

2

3

4

5

6

DVDs Watched per Week

Figure 19-1, Panel (c)

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Figure 19-1, Panels (b) and (c)

2

3

4

5

6

7

DVDs Watched per Week

7 …where marginal utility equals zero.

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Diminishing Marginal Utility

 Observations

 Diminishing Marginal Utility

– Marginal utility falls – Marginal utility = 0 when total utility is at its maximum

– The principle that as more of any good or service is consumed, its extra benefit declines – Increases in total utility from consumption of a good or service become smaller and smaller as more is consumed during a given time period

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Newspaper Vending Machines versus Candy Vending Machines  How many people take more than one paper from the vending machine?  Why not dispense candy the same way?

Optimizing Consumption Choices  Consumer Optimum – A choice of a set of goods and services that maximizes the level of satisfaction for each consumer, subject to limited income

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Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26

Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26

DVDs per Period

Total Utility of DVDs per Period (utils)

Marginal Utility (utils) MUd

Marginal Utility per Dollar Spent (MUd/Pd) (Price = $5)

Pizza Slices per Period

Total Utility of Pizza Slices per Period (utils)

Marginal Utility (utils) MUp

Marginal Utility per Dollar Spent (MUpPp) (price = $3)

0

0.0

——

——

0

0.0

——

——

1

50.0

50.0

10.0

1

25

25

8.3

2

95.0

45.0

9.0

2

47

22

7.3

3

135.0

40.0

8.0

3

65

18

6.0

4

171.5

36.5

7.3

4

80

15

5.0

5

200.0

28.5

5.7

5

89

9

3.0

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Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26 Items per Period

Marginal Utility per Dollar Spent (DVD) (price = $5)

Marginal Utility per Dollar Spent (Pizza) (price = $3)

0

——

——

1

10.0

8.3

2

9.0 8.0

6.0

4

7.3

5.0

5

5.7

Choices DVDs

7.3

3

Steps to Consumer Optimum

3.0

Pizza Slices

Purchase

Unit

(MUd/Pd)

Unit

1

First

10.0

First

8.3

2

Second

9.0

First

8.3

3

Third

8.0

First

8.3

4

Third

8.0

Second

7.3

5

Fourth

7.3

Second

7.3

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Steps to Consumer Optimum Buying Decision First DVD

Remaining Income

$21 - $5 = $16

First pizza slice

$16 - $3 = $13

Third DVD

$13 - $5 = $ 8

Fourth DVD and second pizza slice

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Optimizing Consumption Choices  A little math – The rule of equal marginal utilities per dollar spent

$26 - $5 = $21

Second DVD

(Mup/Pp)

• A consumer maximizes personal satisfaction when allocating money income in such a way that the last dollars spent on good A, good B, good C, and so on yield equal amounts of marginal utility

$8 - $5 = $ 3 $3 - $3 = $ 0

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Optimizing Consumption Choices

How a Price Change Affects Consumer Optimum

 A little math

Income = $26

– The rule of equal marginal utilities per dollar spent MU of good B MU of good A MU of good Z = = ... = price of good B price of good A price of good Z

Qd = 4

MUd 36.5 = 7.3 = Pd 5

Qp = 2

MUp 22 = Pp 3

= 7.3

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How a Price Change Affects Consumer Optimum

How a Price Change Affects Consumer Optimum

Assume Price of DVDs Falls to $4

Assume Price of DVDs Falls to $4

Qd = 4

MUd 36.5 = 9.13 = Pd 4

Qp = 2

MUp 22 = Pp 3

= 7.3

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Now Result

MUd MUp > Pd Pp Buy more DVDs and MUd falls

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DVD Rental Prices and Marginal Utility

How a Price Change Affects Consumer Optimum

Price per Unit ($ per DVD)

 The Substitution Effect – The tendency of people to substitute cheaper commodities for more expensive commodities

A

5

B

4

D 0 Figure 19-2

1

3 2 DVD Rentals per Week

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How a Price Change Affects Consumer Optimum  The Principle of Substitution

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How a Price Change Affects Consumer Optimum  Purchasing Power

– Consumers and producers shift away from goods and resources that become relatively higher priced in favor of goods and resources that are now lower priced

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– The value of money for buying goods and services

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How a Price Change Affects Consumer Optimum  Real-Income Effect

How a Price Change Affects Consumer Optimum  What do you think?

– The change in people’s purchasing power that occurs when, other things being constant, the price of one good that they purchase changes

– Which would usually have more of an impact, the substitution or the realincome effect?

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The Demand Curve Revisited

The Demand Curve Revisited

 Question

 Marginal utility, total utility, and the diamond-water paradox

– How is the demand curve derived?

– Water is essential to life but cheap

 Answer – By assuming income, tastes, expectations, and the price of related goods are not changing as the price and quantity demanded of the good changes Slide 19-35

– Diamonds are not essential to life but expensive

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The Diamond-Water Paradox Price (dollars per kilogram)

Price (dollars per kilogram)

The Diamond-Water Paradox

Pdiamonds

Pwater Ddiamonds

S2

Pdiamonds

Pwater

Dwater

Ddiamonds Qdiamonds

Figure 19-3

Quantity per Period (kilograms)

S1

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Figure 19-3

Dwater

Qwater Quantity per Period (kilograms)

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International Example: The World of Water in Saudi Arabia

Issues and Applications: Consumer Choice and Electronic Tax Filings

 Water is five times more expensive than gasoline in Saudi Arabia.

 Tax preparation software packages vary in price, depending on the features offered.

 Question

 A taxpayer will be willing to pay a higher price for a package that offers her a higher marginal utility.

– How can we explain this reversal of the U.S. prices?

 Electronic filings are less error-prone. Slide 19-39

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Summary Discussion of Learning Objectives

Web Links  The following Web link appears in the margin of this chapter in the textbook: – http://www.finfacts.ie/Private/win_rst/ w_mar24.htm

 Total utility versus marginal utility – Total utility is total satisfaction from consumption – Marginal utility is the additional satisfaction from consuming an additional unit of a good

 Law of diminishing marginal utility – Marginal utility eventually declines with additional consumption

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Summary Discussion of Learning Objectives

Slide 19-42

Summary Discussion of Learning Objectives

 The substitution effect of a price change

 The real-income effect of a price change

– A person will substitute among goods by buying less of a good when its price increases

 The consumer optimum – Occurs when the marginal utility per dollar spent on each good is the same Slide 19-43

– A price change affects the purchasing power of a person’s income

 Why the price of diamonds exceeds the price of water even though people cannot long survive without water – marginal utility determines how much people are willing to buy

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End of Chapter

Chapter 19 Consumer Choice

Copyright © 2004 Pearson Addison Wesley. All rights reserved.

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