Download Chapter 6 CONSUMER CHOICE: INDIVIDUAL AND MARKET

4
Consumer Choice:
Individual and Market
Demand
Everything is worth what its purchaser will pay for it.
PUBLILIUS SYRUS (1ST CENTURY B.C.)
Contents
● Scarcity and Demand
● Utility: A Tool to Analyze Purchase
Decisions
● Consumer Choice as a Trade-off:
Opportunity Cost
● From Individual Demand Curves to Market
Demand Curves
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Contents (continued)
● Exceptions to the Law of Demand
● Appendix: Analyzing Consumer Choice
Graphically: Indifference Curve Analysis
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Scarcity and Demand
● Income is limited.
● Consumer decisions to purchase different
commodities are interdependent.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Utility: A Tool to Analyze
Purchase Decisions
● The Purpose of Utility Analysis
♦ The purpose of utility analysis = analyzing how
people behave rather than how they think
♦ Theory of consumer choice = each consumer
spends his or her income in a way that yields
the greatest satisfaction
♦ Utility = amount of satisfaction
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Utility: A Tool to Analyze
Purchase Decisions
● Total versus Marginal Utility
♦ Total utility = benefit to a consumer from all
the units of a good purchased
♦ Marginal utility = benefit from the last unit of
a good purchased
♦  number of goods purchased   total utility
but a  marginal utility
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Utility: A Tool to Analyze
Purchase Decisions
● The “Law” of Diminishing Marginal Utility
♦ The law of diminishing marginal utility = the
more of a good a consumer has, the less
marginal utility an additional unit contributes
to overall satisfaction
♦ Additional units of a commodity are worth less
and less to a consumer in money terms.
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-1 Your Total and
Marginal Utility for Pizza
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-1 A Marginal Utility
Curve: Your Demand for Pizza
Marginal Utility (Price) per Pizza
FIGURE
$16
A
15
14
B
C
13
12
D
11
P
10
9
E
8
7
6
F
5
4
G
3
2
1
0
P
H
1 2 3 4 5 6 7 8
Number of Pizzas per Month
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Utility: A Tool to Analyze
Purchase Decisions
● Using Marginal Utility: The Optimal
Purchase Rule
♦ Buy the quantity of each good at which price
and marginal utility are exactly equal.
♦ If marginal utility is greater (less) than price,
the consumer can improve well being by
purchasing more (less).
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-2 Finding Your Optimal
Pizza Purchase Quantity
Total Net Utility
FIGURE
$9
8
7
6
5
4
3
2
1
0
–1
–2
M
Total net
utility hill
1 2 3 4 5 6
Number of Pizzas
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Utility: A Tool to Analyze
Purchase Decisions
● From Diminishing Marginal Utility to
Downward-Sloping Demand Curves
♦ Law of diminishing marginal utility 
negative slope of demand curves
♦  price   quantity of demand  
marginal utility
♦ Restores equality between price and marginal
utility
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-2 List of Optimal
Quantities of Pizza
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Consumer Choice as a
Trade-Off: Opportunity Cost
● Decision to purchase something  decision
to forgo something else
● Opportunity cost of spending an extra dollar
on good X = the utility from good Y the
purchaser could have gotten by spending
that dollar on good Y
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Consumer Choice as a
Trade-Off : Opportunity Cost
● Consumer’s Surplus: The Net Gain from a
Purchase
♦ Voluntary purchase  benefit > costs
♦ Consumer’s surplus = net benefit to the buyer
♦ Measured by the sum, over each unit bought, of
the excess of marginal utility above price
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-3 Calculating Marginal
Net Utility (Surplus)
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-3 Graphic Calculation
of Consumer’s Surplus
Marginal Utility and Price per Pizza
FIGURE
$16 $15.00
Marginal utility (demand) curve
A
15
14
$13.00 B
$4.00
13
$12.50C
$11.50 D
12
$2.00
$1.50
11
$0.50
P
P
10
9
$8.00 E
8
7
6
$5.00
5
F
4
$3.00
3
G
2
1
$0
0
1
2
3
4
5
6
7
8
Number of Pizzas Purchased
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
?
Resolving the DiamondWater Paradox
● Diamonds are scarce and unnecessary 
high price and high marginal utility
Resolving the Diamond-Water Paradox
● Water is plentiful and necessary  low
price but greater total utility
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Consumer Choice as a
Trade-Off : Opportunity Cost
● Income and Quantity Demanded
♦  income   purchases of normal goods
Income
and 
Quantity
Demanded
♦  income
 purchases
of inferior goods
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
From Individual to Market
Demand Curves
● Market Demand as a Horizontal Sum
♦ Market demand curve = the horizontal sum of
the individual demand curves
● The “Law” of Demand
♦ Negative slope for market demand curves
■Individual demand curves usually have negative
slopes
■Lower price draws new customers into the market
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-4 Total Market Demand
vs. Individual Consumer Demand
FIGURE
Naomi’s
demand
M
Market demand
Price
$10
A
A
K
Price
Z
Price
D
Alex’s
demand
N
N
C
C
9
D
0
9
Quantity Demanded
(a)
6
Z
0
M
6
Quantity Demanded
(b)
0
15
Quantity Demanded
(c)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
From Individual to Market
Demand Curves
● Exceptions to the Law of Demand
♦ Some inferior goods
♦ Goods whose quality is judged by price
♦ Goods with snob appeal
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Appendix:
Analyzing Consumer
Choice Graphically:
Indifference Curve
Analysis
Geometry of Available
Choices: The Budget Line
● Budget line
♦ Graphical representation of all possible
combinations of a household’s purchases of
two goods, given their prices and a fixed
amount of money to spend
● Properties of the Budget Line
♦ Represents the maximum amounts of the goods
the consumer can afford
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-4 Alternative Purchase
Combinations
TABLE
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-5 A Budget Line
7
Pounds of Cheese
FIGURE
6
A
5
G
B
4
C
3
2
K
D
1
0
1
2
3
E
4
5
6
7
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Geometry of Available
Choices: The Budget Line
● Changes in the Budget Line
♦  income  parallel shift in the budget line
♦  relative prices of the goods 
 slope of the budget line
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-6 The Effect of Income
Changes on the Budget Line
FIGURE
9
U
Pounds of Cheese
8
7
6
5
A
Income = $18
D
4
Income = $12
3
Income = $9
2
1
0
1
2
N
3
E
4
5
P
6
7
8
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-7 The Effect of Price
Changes on the Budget Line
FIGURE
Pounds of Cheese
7
6
A
5
Rubber band
price = $3.00
Rubber band
price = $1.50
4
3
2
1
0
1
2
3
E
4
H
5
6
7
8
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
Properties of the
Indifference Curve
● Indifference curve = a line connecting all
combinations of the goods that are equally
desirable
● Properties of the indifference curve:
♦ higher is better
♦ never intersect
♦ negative slope
♦ bowed in (convex)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-8 3 Indifference Curves
for Cheese and Rubber Bands
FIGURE
Pounds of Cheese
7
6
5
U
4
T
3
2
IC
S
1
0
R
W
1
2
Ib
Ia
3
4
5
6
7
8
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Slopes of Indifference
Curves and Budget Lines
● Slope of the indifference curve =
marginal rate of substitution of the two
goods
● The slope of the budget line = relative
prices of the two goods
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-9 Slopes of a Budget
Line and an Indifference Curve
FIGURE
I
Pounds of Cheese
M
B
R
N
m
D
n
r
E
I
F
B
0
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
FIGURE
4-10 Optimal Consumer
Choice
Pounds of Cheese
7
6
Ic
I aI b
5
4
U
T
3
2
K
1
0
W
1
2
3
4
5
6
7
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Slopes of Indifference
Curves and Budget Lines
● Tangency Conditions
♦ Utility maximization point on the budget line
tangent to an indifference curve
♦ Marginal rate of substitution = price ratio at
that point
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Slopes of Indifference
Curves and Budget Lines
● Consequences of Income Changes: Inferior
Goods
♦ Inferior goods: indifference curves located
such that  income 
■  purchases of one good
■  purchases of the other
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-11 Rise in Income
When Neither Good Is Inferior
FIGURE
C
Optimal
consumption
curve
Pounds of Cheese
B
E
T
I2
I1
B
0
1
2
3
C
4
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-12 Rise in Income,
Rubber Bands Are Inferior Good
FIGURE
Pounds of Cheese
C
Optimal
consumption
curve
B
G
H
B
0
1
2
3
C
4
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
The Slopes of Indifference
Curves and Budget Lines
● Consequences of Price Changes: Deriving
the Demand Curve
♦  slope of the budget line
♦  quantity purchased of that good
♦  quantity of the other good
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-13 Consequences of
Price Changes
Pounds of Cheese
FIGURE
6
B
E
3 3–4
T
3
C
0
2
3
D
8
4
Boxes of Rubber Bands
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.
4-14 Deriving the
Demand Curve for Rubber Bands
Price of Rubber Bands per Box
FIGURE
D
$4.00
t
3.00
e
1.50
D
1
2
3
4
Quantity of Rubber Bands
Demanded (boxes)
Copyright© 2003 South-Western/Thomson Learning. All rights reserved.