ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 21:
Consumer Choice
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.
Utility Theory

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
2
Utility Theory

Marginal Utility
 The
change in total utility due to
a one-unit change in the quantity
of a good or service consumed
change in total utility
Marginal utility =
change in number of units consumed
3
Total and Marginal Utility
of Watching DVDs
Figure 20-1, Panel (a)
4
Total and Marginal Utility
of Watching DVDs
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
8
6
4
2
0
-2
1
-4
1
2
3
4
5
6
DVDs Watched per Week
Figure 20-1, Panels (b) and (c)
7
…where marginal
utility equals zero.
2
3
4
5
6
7
DVDs Watched per Week
5
Total and Marginal Utility
of Watching Videos

Observations


Marginal utility falls as more is consumed
Marginal utility equals zero when total utility
is at its maximum
6
Diminishing Marginal Utility

Diminishing Marginal Utility
 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
7
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
8
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)
0
0.0
——
——
1
50.0
50.0
10.0
2
95.0
45.0
9.0
3
135.0
40.0
8.0
4
171.5
36.5
7.3
5
200.0
28.5
5.7
Table 20-1
9
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
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
——
——
1
25
25
8.3
2
47
22
7.3
3
65
18
6.0
4
80
15
5.0
5
89
9
3.0
Table 20-1
10
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
Table 20-1
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
7.3
3
8.0
6.0
4
7.3
5.0
5
5.7
3.0
11
Steps to Consumer Optimum
Buying Decision
First DVD
$26 - $5 = $21
Second DVD
$21 - $5 = $16
First pizza slice
$16 - $3 = $13
Third DVD
$13 - $5 = $ 8
Fourth DVD and
Second pizza slice
Table 20-2
Remaining Income
$8 - $5 = $ 3
$3 - $3 = $ 0
12
Optimizing Consumption Choices

A little math
 The
rule of equal marginal utilities
per dollar spent

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
13
Optimizing Consumption Choices

A little math
 The
rule of equal marginal utilities per dollar
spent
MU of good A
MU of good B
MU of good Z
=
= ... =
price of good A
price of good B
price of good Z
14
How a Price Change
Affects Consumer Optimum
Income = $26
Qd = 4
MUd
36.5
= 7.3
=
Pd
5
Qp = 2
MUp
22
= 7.3
=
Pp
3
15
How a Price Change
Affects Consumer Optimum
Assume Price of DVDs Falls to $4
Qd = 4
MUd
36.5
= 9.13
=
Pd
4
Qp = 2
MUp
22
= 7.3
=
Pp
3
16
How a Price Change
Affects Consumer Optimum
Assume Price of DVDs Falls to $4
Now
Result
MUd
MUp
>
Pd
Pp
Buy more DVDs
and MUd falls
17
Price per Unit ($ per DVD)
DVD Rental Prices
and Marginal Utility
A
5
B
4
D
0
Figure 20-2
1
2
3
DVD Rentals per Week
18
How a Price Change
Affects Consumer Optimum

The Substitution Effect
 The
tendency of people to substitute cheaper
commodities for more expensive commodities

Purchasing Power
 The
value of money for buying goods and
services

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 changes19
ECON 152 – PRINCIPLES OF MICROECONOMICS
Chapter 21:
Consumer Choice
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.
ECON 152 – PRINCIPLES OF MICROECONOMICS
Appendix E
Indifference Curve Analysis
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.
Figure E-1 Combinations That Yield Equal
Levels of Satisfaction
Figure E-2 Indifference Curves:
Impossibility of an Upward Slope
Figure E-3 Implications of a Straight-Line
Indifference Curve
Table E-1 Calculating the Marginal Rate of
Substitution
Figure E-4
A Set of Indifference Curves
Figure E-5 The Budget Constraint
Figure E-6 Consumer Optimum
Deriving Demand Curve from Indifference
Analysis
If the price of meals drops, the consumer
can buy more. The Budget Constraint shifts
outward along the meals axis. The new
point of indifference will be at a higher
quantity per week. Thus, lower P, higher QD.
ECON 152 – PRINCIPLES OF MICROECONOMICS
Appendix E
Indifference Curve Analysis
Materials include content from Pearson Addison-Wesley which has been modified
by the instructor and displayed with permission of the publisher. All rights reserved.