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PrinciplesofMicroeconomicsModule3
TheoryofConsumerChoiceandDerivingtheDemandCurve
UtilityConsumersderivesatisfactionfromthegoodsandservicestheyconsume• Thisiscalled“utility”
• TotalUtility:Totallevelofsatisfactionfromconsumingagivenquantityofagood
• MarginalUtility:Additionalsatisfactionderivedfromconsumingonemoreunitofthegood
Total Utility and Marginal UtilityNumberofCandyBars TotalUtility Marginal
Utility0 01 25 252 45 203 60 154 70 105 75 56 75 07 70 -58 60 -109 45 -1510 25 -20
MarginalUtilityisPositiveTotalUtilityisIncreasing
MarginalUtilityisNegativeTotalUtilityisDecreasing
Total Utility and Marginal Utility
NumberofCandyBarsEaten NumberofCandyBarsEaten
Utils Utils
0123456789 0123456789
100
80
60
40
20
Total Utility Marginal Utility
252015
105
Diminishing Marginal Utility
NumberofCandyBarsEaten NumberofCandyBarsEaten
Utils Utils
0123456789 0123456789
100
80
60
40
20
Total Utility Marginal Utility
252015
105
Occurswhenmarginalutilitydeclinesasconsumptionincreases
Consumer’s OptimalDecisions• Consumeroptimizeshisconsumptiondecisionwhenhemaximizeshislevelofsatisfaction
• Thisoccurswhenhegetsthemaximumlevelofutilityforeachdollarhespendsonagood
Understanding Optimal ChoiceSupposeyouhave$5tospendonpizzaandsoda.Pizzacosts$2persliceandsodacosts$1percan.Whatcombinationofpizzaandsodaisbestforyou?
SodaConsumed
MarginalUtilityfromSoda
PizzaConsumed
MarginalUtilityfromPizza
1 8 1 202 7 2 163 6 3 124 5 4 85 4 5 4
Understanding Optimal ChoiceSupposeyouhave$5tospendonpizzaandsoda.Pizzacosts$2persliceandsodacosts$1percan.Whatcombinationofpizzaandsodaisbestforyou?
SodaConsumed MarginalUtilityfromSoda PizzaConsumed MarginalUtility
fromPizza1 8 1 202 7 2 163 6 3 124 5 4 85 4 5 4
Soda Pizza TotalUtility5 0 (8+7+6+5+4)=30utils3 11 2 (9)+(20+16)=45utils
Understanding Optimal ChoiceSupposeyouhave$5tospendonpizzaandsoda.Pizzacosts$2persliceandsodacosts$1percan.Whatcombinationofpizzaandsodaisbestforyou?
SodaConsumed MarginalUtilityfromSoda PizzaConsumed MarginalUtility
fromPizza1 8 1 202 7 2 163 6 3 124 5 4 85 4 5 4
Soda Pizza TotalUtility5 0 (8+7+6+5+4)=30utils3 1 (8+7+6)+(20)=41utils1 2 (9)+(20+16)=45utils
Understanding Optimal ChoiceSupposeyouhave$5tospendonpizzaandsoda.Pizzacosts$2persliceandsodacosts$1percan.Whatcombinationofpizzaandsodaisbestforyou?
SodaConsumed MarginalUtilityfromSoda PizzaConsumed MarginalUtility
fromPizza1 8 1 202 7 2 163 6 3 124 5 4 85 4 5 4
Soda Pizza TotalUtility5 0 (8+7+6+5+4)=30utils3 1 (8+7+6)+(20)=41utils1 2 (8)+(20+16)=44utils
Understanding Optimal ChoiceRememberthataconsumeroptimizeshisconsumptiondecisionwhenhemaximizeshislevelofsatisfaction– getsthemostutilityforeachdollarhespend
SodaConsumed
MarginalUtilityfrom
SodaMU/P Pizza
Consumed
MarginalUtilityfrom
PizzaMU/P
1 8 8 1 20 102 7 7 2 16 83 6 6 3 12 64 5 5 4 8 45 4 4 5 4 2
Attheoptimalconsumption choice:MU/Pofeachgoodisequal
Price Changes• Ifthepriceofonegoodchanges,itwillchangethemarginalutilityperdollarspentonthegood– thereforetheoptimalconsumptionbundlewillchange
• IncreaseinPrice:MU/PislowerConsumerswillbuylessofthegood
• DecreaseinPrice:MU/PishigherConsumerswillbuymoreofthegood
Price Changes• Ifthepriceofpizzafallsto$1….
SodaConsume
d
MarginalUtility
fromSodaMU/P
PizzaConsume
d
MarginalUtility
fromPizzaMU/P
1 8 8 1 20 202 7 7 2 16 163 6 6 3 12 124 5 5 4 8 85 4 4 5 4 4
Price Changes• Ifthepriceofpizzafallsto$1….
SodaConsumed
MarginalUtilityfrom
SodaMU/P Pizza
Consumed
MarginalUtilityfrom
PizzaMU/P
1 8 8 1 20 202 7 7 2 16 163 6 6 3 12 124 5 5 4 8 85 4 4 5 4 4
Soda Pizza TotalUtility
5 0 (8+7+6+5+4)=30utils
3 2 (8+7+6)+(20+16)=57utils
2 3 (8+7)+(20+16+12)=63utils
1 4 (8)+(20+16+12+8)=64utils
0 5 (20+16+12+8)=56utils
Price Changes• Ifthepriceofpizzafallsto$1….
SodaConsumed
MarginalUtilityfrom
SodaMU/P Pizza
Consumed
MarginalUtilityfrom
PizzaMU/P
1 8 8 1 20 202 7 7 2 16 163 6 6 3 12 124 5 5 4 8 85 4 4 5 4 4
Soda Pizza TotalUtility
5 0 (8+7+6+5+4)=30utils
3 2 (8+7+6)+(20+16)=57utils
2 3 (8+7)+(20+16+12)=63utils
1 4 (8)+(20+16+12+8)=64utils
0 5 (20+16+12+8)=56utils
Price Changes• Ifthepriceofpizzafallsto$1….
SodaConsumed
MarginalUtilityfrom
SodaMU/P Pizza
Consumed
MarginalUtilityfrom
PizzaMU/P
1 8 8 1 20 202 7 7 2 16 163 6 6 3 12 124 5 5 4 8 85 4 4 5 4 4
Soda Pizza TotalUtility
5 0 (8+7+6+5+4)=30utils
3 2 (8+7+6)+(20+16)=57utils
2 3 (8+7)+(20+16+12)=63utils
1 4 (8)+(20+16+12+8)=64utils
0 5 (20+16+12+8)=56utils
PriceChanges• Ifthepriceofpizzafallsto$1….
SodaConsumed
MarginalUtilityfrom
SodaMU/P Pizza
Consumed
MarginalUtilityfrom
PizzaMU/P
1 8 8 1 20 202 7 7 2 16 163 6 6 3 12 124 5 5 4 8 85 4 4 5 4 4
Soda Pizza TotalUtility
5 0 (8+7+6+5+4)=30utils
3 2 (8+7+6)+(20+16)=57utils
2 3 (8+7)+(20+16+12)=63utils
1 4 (8)+(20+16+12+8)=64utils
0 5 (20+16+12+8)=56utils
Price Changes• Ifthepriceofpizzafallsto$1….
SodaConsumed
MarginalUtilityfrom
SodaMU/P Pizza
Consumed
MarginalUtilityfrom
PizzaMU/P
1 8 8 1 20 202 7 7 2 16 163 6 6 3 12 124 5 5 4 8 85 4 4 5 4 4
Soda Pizza TotalUtility
5 0 (8+7+6+5+4)=30utils
3 2 (8+7+6)+(20+16)=57utils
2 3 (8+7)+(20+16+12)=63utils
1 4 (8)+(20+16+12+8)=64utils
0 5 (20+16+12+8)=56utils
Individual DemandRecallthechangesweobservedinthepriceofpizza:
19
PriceofPizza
QuantityConsumed
$1 4pizzas$2 2pizzas
DemandScheduleforoneconsumerDeterminestheconsumer’sdemandcurve
Sumofallindividualdemandcurvesdeterminesmarketdemandcurve
P
Q
$2
$1
24Demand
Income Effect
• IncomeEffect:WhenthepriceofGoodXfalls,incomedoesnotchangebutwe“feelwealthier”becauseeachdollarinourpocketcanbuymoreofGoodXandmoreofGoodY
• Aspizzabecomescheaper:theconsumerbuysmorepizzaandsoda
SubstitutionEffect
• SubstitutionEffect:GoodYhasbecomemoreexpensiveintermsofgoodGoodX:ConsumemoreofGoodXandlessofGoodY
• Aspizzabecomescheaper:theconsumerbuysmorepizzabutlesssoda
Key Takeaways• Consumer’soptimalchoicedependonbothhowmuchtheycanaffordandwhatmaximizestheirutility/satisfaction
• Whenthepriceofagoodchanges,theconsumerwillrespondbybuyingmore/lessofthegood,aswellasadjustingtheirconsumptionoftherelatedgood
• Theoptimalconsumptionpointdeterminesanindividualconsumer’sdemandcurve,whichinturndeterminesthemarketdemandcurve