Bec doms ppt on consumer choice

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Bec doms ppt on consumer choice

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Bec doms ppt on consumer choice

  1. 1. Consumer Choice <ul><li>Utility </li></ul><ul><li>Consumer surplus </li></ul><ul><li>Budget Constraints </li></ul><ul><li>Indifference Curves </li></ul>
  2. 2. I. Utility Analysis <ul><li>what is utility? </li></ul><ul><ul><li>benefit you get from consuming a good </li></ul></ul><ul><ul><li>determined by your tastes/preferences </li></ul></ul><ul><ul><li>(assume these are stable) </li></ul></ul>
  3. 3. total utility (TU) <ul><li>total benefit from consuming good </li></ul><ul><li>example </li></ul><ul><ul><li>total benefit from 3 cookies </li></ul></ul>
  4. 4. <ul><li>TU increases as consumption increases, to a point </li></ul>< TU 2 cookies TU 3 cookies
  5. 5. marginal utility (MU) <ul><li>change in TU from </li></ul><ul><li>consuming one more of a good </li></ul><ul><li>example </li></ul><ul><ul><li>how much MORE utility from </li></ul></ul><ul><ul><li>an additional pack of gum? </li></ul></ul>
  6. 6. change in TU from 0 to 1 cookie change in TU from 1 cookie to 2 cookies MU of 1 st cookie MU of 2 nd cookie = = 0
  7. 7. diminishing marginal utility <ul><li>MU falls as consumption rises </li></ul><ul><li>get sick of cookies </li></ul>
  8. 8. MU of 1 st cookie > MU of 2 nd cookie 0
  9. 9. TU rises at slower and slower rate as MU declines TU cookie MU cookie
  10. 10. How to maximize TU? <ul><li>use available budget </li></ul><ul><li>equalize MU/$ across goods </li></ul><ul><li>Huh? </li></ul>
  11. 11. <ul><li>chose combination of cookies and milk where </li></ul>price of cookies price of milk MU cookies = MU milk
  12. 12. why? <ul><li>chose combo of 6 cookies, 1 milk </li></ul><ul><li>suppose MU/$1 of cookies = 4, </li></ul><ul><li>MU/$1 of milk = 15 </li></ul><ul><li>by consuming fewer cookies, more milk… </li></ul><ul><li>I would add more to my TU </li></ul>
  13. 13. TU vs. MU <ul><li>Diamond-Water paradox </li></ul><ul><li>$10,000 </li></ul><ul><ul><li>one carat diamond </li></ul></ul><ul><ul><li>5 million gallons of tap water </li></ul></ul>
  14. 14. why? <ul><li>TU of water is greater than TU of diamonds </li></ul><ul><ul><li>water is essential for life </li></ul></ul><ul><li>BUT water is abundant, diamonds are rarer </li></ul><ul><ul><li>MU of last diamond is higher </li></ul></ul><ul><li>MU determines value </li></ul>
  15. 15. MU and demand <ul><li>MU declines as consumption rises </li></ul><ul><li>willing to pay less for each additional unit </li></ul><ul><ul><li>downward sloping demand </li></ul></ul>
  16. 16. example : pizza for 4th pizza for 2nd pizza P Q D $10 4 pizzas willing to pay $10 $15 2 pizza willing to pay $15
  17. 17. II. Consumer Surplus <ul><li>difference between what you pay for a good, </li></ul><ul><li>any what you are WILLING to pay for a good </li></ul>
  18. 18. example <ul><li>market price pizza = $10 </li></ul><ul><li>my marginal value of 3rd pizza this week = $12 </li></ul><ul><li>my consumer surplus = $2 </li></ul>
  19. 19. my demand curve P Q D $10 $12 3 my consumer surplus
  20. 20. area between D and price of pizza P Q D $10 10,000 total consumer surplus
  21. 21. III. The Budget Line <ul><li>given: </li></ul><ul><ul><li>consumer’s budget </li></ul></ul><ul><ul><li>prices </li></ul></ul><ul><li>draw a line representing choices </li></ul><ul><li>consumption possibilities </li></ul>
  22. 22. example <ul><li>2 goods: milk & cookies </li></ul><ul><li>bottle of milk = $1 </li></ul><ul><li>cookie = $.50 </li></ul><ul><li>daily budget = $4 </li></ul>
  23. 23. possible combinations 0 2 4 6 8 4 3 2 1 0 cookies milk
  24. 24. budget line milk cookies 8 4 2 6 0 4 2 1 3
  25. 25. budget line milk cookies Affordable Unaffordable 8 4 2 6 0 4 2 1 3
  26. 26. what if prices change? <ul><li>changes slope of budget line </li></ul><ul><li>suppose cookies = $1 </li></ul>
  27. 27. budget line milk cookies 8 4 2 6 0 4 2 1 3 cookie = $.50 cookie = $1
  28. 28. what if budget changes <ul><li>budget line shifts </li></ul><ul><li>suppose budget = $5 </li></ul>
  29. 29. milk cookies budget = $4 budget = $5 8 4 2 6 0 10 4 2 1 3 5
  30. 30. IV. Indifference Curves <ul><li>(appendix) </li></ul><ul><li>alternative way to show utility </li></ul><ul><li>curve shows combo of goods </li></ul><ul><li>that deliver same total utility </li></ul>
  31. 31. example: milk and cookies milk cookies Every point on curve has same total utility 8 4 2 6 0 4 2 1 3 Indifference curve
  32. 32. TU is higher as curve shifts right milk cookies higher TU lower TU
  33. 33. consumer equilibrium <ul><li>maximize TU </li></ul><ul><li>stay on budget </li></ul>
  34. 34. consumer equilibrium best affordable point cookies 8 milk 4 4 2
  35. 35. consumer equilibrium best affordable point cookies 8 milk 4 4 2
  36. 36. sum it up <ul><li>consumer decisions based on </li></ul><ul><ul><li>preferences </li></ul></ul><ul><ul><li>budget constraint </li></ul></ul><ul><li>consumer decisions made at the margin </li></ul><ul><ul><li>marginal benefit of one more </li></ul></ul><ul><ul><li>compared to price of one more </li></ul></ul>

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