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A Lecture Presentation
to accompany
Exploring Economics
3rd Edition
by Robert L. Sexton
Copyright © 2005 Thomson Learning, Inc.
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Printed in the United States of America
ISBN 0-324-26086-5
Copyright © 2002 by Thomson Learning, Inc.
Chapter 9
Consumer Choice
Copyright © 2002 by Thomson Learning, Inc.
9.1 Consumer Behavior
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Individuals take action in response to
recognized opportunities to advance
their goals.
This assumption that individuals act
to advance their goals—known as
the rule of rational choice—merely
implies that whatever individuals
do is done with a purpose.
Copyright © 2002 by Thomson Learning, Inc.
Utility


In economics we assume that each
individual seeks to maximize his or
her own well-being or satisfaction.
Economists developed the concept of
utility to allow them to study the
relative levels of satisfaction that
consumers get from the consumption
of goods and services.
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Utility is a Personal Matter
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Utility varies from individual to
individual depending on specific
preferences.
Therefore, it is not possible to
compare the relative satisfactions
of different persons.
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Total Utility and Marginal Utility

Total utility is the total amount
of satisfaction derived from the
consumption of a certain number
of units of a good or service.
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
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Marginal utility is the additional
satisfaction generated by the last unit
of a good that is consumed.
Total utility increases with additional
consumption.
The incremental satisfaction–the
marginal utility–that results from the
consumption of additional units tends
to decline as consumption increases.
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Diminishing Marginal Utility

The law of diminishing marginal
utility means that each successive
unit of a good that is consumed
generates less additional satisfaction
than did the previous unit.
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Copyright © 2002 by Thomson Learning, Inc.

It follows from the law of diminishing
marginal utility that as a person uses
more and more units of a good to
satisfy a given want, the intensity of
the want, and the utility derived from
further satisfying that want,
diminishes.
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9.2 The Consumer's Choice

Consumers try to add to their total
utility, so when the marginal utility
generated by the purchase of
additional units of one good drops
too low, it can become rational for
the consumer to purchase other
goods rather than to purchase more
of the first good.
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What is the “Best” Decision for
Consumers?
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A rational consumer will avoid making
purchases of any one good beyond
the point at which other goods will
yield greater satisfaction for the
amount spent.
Marginal utility is an important
concept in understanding and
predicting consumer behavior.
Copyright © 2002 by Thomson Learning, Inc.

By comparing the marginal utilities
generated by units of the goods that
he or she desires as well as their
prices, a rational consumer seeks the
combination of goods that maximizes
his or her satisfaction.
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Consumer Equilibrium

When the optimum, utilitymaximizing level of each good has
been purchased, consumers are
said to have reached the point of
consumer equilibrium.
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

In order to reach consumer equilibrium,
consumers must allocate their income in
such a way that the ratio of the marginal
utility to the price of the good is equal for
all goods purchased.
When this goal is realized, one dollar's
worth of additional gasoline will yield the
same marginal utility as one dollar's worth
of additional bread or apples or movie
tickets or soap.
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
Given a fixed budget, if the marginal
utilities per dollar spent on additional
units of two goods are not the same,
the consumer can increase total
satisfaction by buying more of a good
with a higher marginal utility per
dollar and less of another good with
a lower marginal utility per dollar.
Copyright © 2002 by Thomson Learning, Inc.


Consumers will continue to alter their
purchases to increase their satisfaction
until the ratio of the marginal utility to
the price of each good is equal for all
goods purchased.
The law of demand—buying more of a
good as its price is reduced—reflects
consumer equilibrium where goods are
subject to the law of diminishing marginal
utility.
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The Law of Demand and the Law
of Diminishing Marginal Utility
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The law of demand states that when
the price of a good is reduced, the
quantity of that good demanded will
increase.
By examining the law of diminishing
marginal utility in action, we can
determine the basis for this
relationship between price and
quantity demanded.
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Appendix: A More Advanced
Theory of Consumer Choice

We will develop a more advanced set
of tools using indifference curves
and budget lines to aid in our
understanding the theory of
consumer choice.
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Indifference Curves

A consumer’s indifference curve contains
various combinations of two commodities
and each combination of goods (like points
A, B, and C) on the indifference curve will
yield the same level of total utility to this
consumer.

The consumer is said to be indifferent between
any combination of the two goods along an
individual indifference curve, because the
consumer receives the same level of satisfaction
from each bundle.
Copyright © 2002 by Thomson Learning, Inc.
Copyright © 2002 by Thomson Learning, Inc.
The Properties of the
Indifference Curve

Three properties of indifference
curves:
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higher indifference curves represent
greater satisfaction
they are negatively sloped
they are convex from the origin
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
Higher indifference curves represent
greater satisfaction

Although equally happy with any bundle
of goods along the indifference curve,
consumers prefer to be on the highest
indifference curve possible.
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Copyright © 2002 by Thomson Learning, Inc.

Consumer would prefer I2 to I1.
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Bundle D gives the consumer more of
both goods than bundle C, which is on a
lower indifference curve.
Bundle D is also preferred to bundle A
because there is more than enough extra
food to compensate the consumer for the
loss of clothing; his total utility has risen.
Copyright © 2002 by Thomson Learning, Inc.

Indifference curves are negatively
sloped.
 must slope downward from left to
right
 If both goods are desirable and the
quantity of one good is reduced,
the quantity of the other good
must be increased to maintain the
same level of total satisfaction.
Copyright © 2002 by Thomson Learning, Inc.

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Indifference curves are convex from
the origin.
The slope of the indifference curve
reflects the marginal rate of
substitution.
The rate at which a consumer is
willing to trade one good to gain one
more unit of another good.
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
If the indifference curve is steep,
the marginal rate of substitution is
high.
 The consumer would be willing to
give up a large amount of A for a
small amount of B.
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Copyright © 2002 by Thomson Learning, Inc.


If the indifference curve is flatter, the
marginal rate of substitution is low.
The consumer is only willing to give up a
small amount of A in exchange for an
additional unit of B to remain indifferent
 If you have lots of something, you will
not value the prospect of getting even
more of it more highly; this is just the
law of demand, which is based on the
law of diminishing marginal utility.
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
Complements – the use of more units of
one encourages the acquisition of
additional units of the other.
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gasoline and automobiles
baseballs and baseball bats
snow skis and bindings
bread and butter
coffee and cream
When goods are complements, units of one
good cannot be acquired without affecting
the want-satisfying power of other goods.
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
Substitutes-the more you have of
one, the less your desire the other.
coffee and tea
 sweaters and jackets
 home-cooked and restaurant meals

Copyright © 2002 by Thomson Learning, Inc.

The degree of convexity of an
indifference curve—that is, the extent
to which the curve deviates from a
straight line—depends on how easily
the two goods can be substituted for
each other.

Perfect substitutes, the indifference
curve is a straight line (in this case of
slope –1).
Copyright © 2002 by Thomson Learning, Inc.

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Perfect complements, goods are never
used separately but are consumed only
together.
 left and right shoes
Since it is impossible to replace units
of one with units of the other and
maintain satisfaction, the marginal rate
of substitution is undefined; thus, the
indifference curve is a right angle.
Copyright © 2002 by Thomson Learning, Inc.
Copyright © 2002 by Thomson Learning, Inc.

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If two commodities can easily be
substituted for one another, the
nearer the indifference curves will
approach a straight line.
The greater the complementarity
between the two goods, the nearer
the indifference curves will approach
a right angle.
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The Budget Line

A budget line represents the various
combinations of two goods that a
consumer can buy with a given
income, holding the prices of the two
goods constant.


The horizontal axis measures the
quantity of clothing.
The vertical axis measures the quantity
of food.
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

Moving along the budget line, we can
see the various combinations of food
and clothing the consumer can
purchase with her income.
Any combination of goods beyond the
budget line is not feasible.
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
The intercept can easily be found by
dividing the total income available for
expenditures by the price of the good
in question.
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

The slope of the budget line is equal
to -PX/PY.
The negative coefficient of the slope
indicates that the budget line is
negatively sloped (downward
sloping), reflecting the fact that you
must give up some of one good to
get more of the other.
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Consumer Optimization

Given the consumer’s indifference
curves for two goods, together with
the budget line showing the various
quantities of the two that can be
purchased with a given money
income for expenditure, the optimal
(or best) quantities of each good to
be purchased can be determined.
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Copyright © 2002 by Thomson Learning, Inc.

The optimum occurs where the budget line is
tangent to indifference curve I1, at point A.
 To maximize satisfaction, the consumer
must acquire the most preferred
attainable bundle, that is, reach the
highest indifference curve that can be
reached with a given level of income.
 The highest curve that can be reached is
the one to which the budget line is
tangent, at point A.
Copyright © 2002 by Thomson Learning, Inc.
Changes in the Budget Line

The position of the budget line if income rises
 An increase in income, holding relative
prices constant, will cause the curve to shift
out parallel to the old curve.
 A richer person can afford more of both
goods than a poorer person because of
the higher budget line.
 The change in income, holding relative
prices constant, is called the income effect
and it causes this parallel shift in the budget
line.
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
Income-consumption curve (ICC)

a curve that connects the various
optimum combinations of two goods as
a consumer’s income changes
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Copyright © 2002 by Thomson Learning, Inc.

With a given pattern of indifference
curves, larger amounts available for
spending will result in an income
consumption curve (ICC) connecting
the best consumption points
(tangencies) at each income level.
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
The rise in income shifts the budget
line outward.


If both goods are normal goods in this
range, then the consumer will buy more
of both goods
If income rises and the consumer buys
less of one good, we say that good is an
inferior good.
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Quantity of Clothing
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Purchases depend on relative prices as
well as income level.
When the price of one good changes,
holding income and the price of the
other good constant, it causes a relative
price effect.
Relative prices affect the way the
consumers allocates their income among
different goods.
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

A price change of the good on either
the Y- or X-axis causes the budget
line to rotate inward or outward from
the intercept on the other axis.
This fall in price expands consumers’
buying opportunities—rotating the
budget line outward.
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
The tangency relationship between
the budget line and the indifference
curve indicates the optimal amounts
of each of the two goods the
consumer will purchase, given


the prices of both goods
the consumer’s total available income for
expenditures
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

At different possible prices for one of the
goods, given the price of the other and
given total income, a consumer would
optimally purchase different quantities
of the two goods.
A change in the price of one of the
goods will alter the slope of the budget
line because a different amount of the
good can be purchased with a given
level of income.
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Copyright © 2002 by Thomson Learning, Inc.
Copyright © 2002 by Thomson Learning, Inc.

The point of tangency moves from A
to B as a result of the decline in
price of food from $10 to $5; the
equilibrium quantity of food
purchased increases from two to
five units.
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

Price-consumption curve (PCC)-a curve
consisting of the various optimum
combinations of two goods as the
relative price of one good changes
The price-consumption curve (PCC)
may be drawn through these points
of tangency, indicating the optimum
quantities at various possible prices
of food (given the price of clothing).
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

From this price-consumption curve
can be derived the usual demand
curve for the good.
Essentially, the demand curve is
made up of various price and
quantity optimum points.
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