Chapter 20Consumer Choice

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Utility Theory Utility

The want-satisfying power of a good or service Basically, it’s another word for satisfaction Purely subjective- you can’t measure my utility

Utility Analysis The analysis of consumer decision making based

on utility maximization

Utils

Unit used when talking about utility

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Utility Total utility versus marginal utility

Total utility is total satisfaction from consumption.

Marginal utility is the additional satisfaction from consuming an additional unit.

Law of diminishing marginal utility Marginal utility ultimately declines as a

person consumes more and more of a good or service.

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Utility Theory (cont'd) Marginal (additional, incremental) Utility

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

mmm…Donutsmmm…Donuts

Maybe one more

Maybe one more

No more Donuts!

No more Donuts!

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Figure 20-1 Total and Marginal Utility of Downloading and Listening to Digital

Music Albums

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Figure 20-1 Total and Marginal Utility of Downloading and Listening to Digital Music Albums

•As each album is listened to, enjoyment increases until this point

Total utility ismaximized...

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Figure 20-1 Total and Marginal Utility of Downloading and Listening to Digital Music Albums

•This graph showsthe decline ofmarginal utility

…where marginalutility equals zero.

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Graphical Analysis (cont'd) Observations

Marginal utility falls as more is consumed.

Marginal utility equals zero when total utility is at its maximum.

You couldn’t be any happier!

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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?

The answer is found in the concept of

diminishing marginal utility.

The utility for candy is (in most cases)

greater than it is for a newspaper

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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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If you spend your income wisely you can enjoy music and sandwiches!!!

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How a Price Change Affects Consumer Optimum

The Substitution Effect

The tendency of people to substitute cheaper commodities for more expensive commodities

The Principle of Substitution

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

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How a Price Change Affects Consumer Optimum

The substitution effect of a price change

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

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How a Price Change Affects Consumer Optimum

Purchasing Power

The value of money for buying goods and services

What happens to your purchasing power at Wal-Mart?

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How a Price Change Affects Consumer Optimum (cont'd)

Real-Income Effect

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

When that price goes up (down), real income, or purchasing power, falls (increases). (Wal-Mart)

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How a Price Change Affects Consumer Optimum

Question???

What do you think: Which would usually have more of an impact on your purchases—the substitution effect or the real-income effect?

Discuss this with your neighbor! NOW!!!

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The Demand Curve Revisited

Question How is the demand curve derived?

Answer By assuming income, tastes,

expectations, and the price of related goods are not changing as the price of the good changes

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The Demand Curve Revisited (cont'd)

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

Water is essential to life but cheap.

Diamonds are not essential to life but expensive.

End of Chapter 20