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Utility for Pisay
 

Utility for Pisay

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Utility ppt.

Utility ppt.

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    Utility for Pisay Utility for Pisay Presentation Transcript

    • Consumer Choice: Maximizing Utility
    • Definition….• Utility: A measure of the satisfaction, happiness, or benefit that results from the consumption of a good. – Util: An artificial construct used to measure utility.• Total Utility: The total satisfaction received from consuming a particular quantity of a good.• Marginal Utility: The additional utility a person receives from consuming an additional unit of a good.
    • Demand for Mogu-Mogu
    • Think• Diamonds vs. Water – Total Utility versus marginal utility• Goods change as we become more familiar with them…• Interpersonal utility comparisons. – We often do compare marginal utility of additional income across different income levels, but it is not always appropriate…
    • Normally• Income is limited! – You have to make trade-offs in purchasing different goods…• Example: – To buy 1 more Justin Bieber CD at Php375, need to give up something else, i.e., 3 Starbucks Lattes at Php125 each….• The trade-off occurs ―rationally” because you know how much you value each of these goods.
    • The Budget Constraint• Virtually all individuals must face two facts of economic life – Have to pay prices for the goods and services they buy – Have limited funds to spend• A consumer’s budget constraint identifies which combinations of goods and services the consumer can afford with a limited budget• Budget line is the graphical representation of a budget constraint – The price of one good relative to the price of another – The slope of the budget line indicates the spending trade-off between one good and another • Amount of one good, that must be sacrificed in order to buy more of another good 6
    • The Budget ConstraintNumber of With Php1500 per month,Movies per Month Iego can afford 15 movies and no concerts, . . . 15 A 12 movies and 1Sarah geronimo B concert or any other combination on 12 the budget line. 9 C Points below the line are H also affordable. 6 D G But not points E above the line. 3 F 1 2 3 4 5 Number of Concerts per Month 7
    • Changes in the Budget Line• Changes in income – Increase in income will shift the budget line upward (and rightward) – A decrease in income will shift the budget line downward (and leftward) – Shifts are parallel• Changes in price – In each case, one of the budget line’s intercepts will change, as well as its slope • When the price of a good changes, the budget line rotates – Both its slope and one of its intercepts will change 8
    • Shifting of the Budget Line (a)Number of Movies per Month 1. An increase in income shifts 30 the budget line rightward, with no change in slope. 15 5 10 15 Number of Concerts per 9 Month
    • Changes in the Budget Line (b)Number of Movies per Month 2. A decrease in the price of 30 movies rotates the budget line upward. 15 5 15 Number of Concerts per 10 Month
    • Changes in the Budget Line (c)Number of Movies per Month 3. while a decrease in the price of 30 concerts rotates it rightward. 15 5 15 Number of Concerts per 11 Month
    • Rationality(Indifference Curve)• One common denominator – People have preferences – We assume that you can look at two alternatives and state either that you prefer one to the other or • That you are entirely indifferent between the two—you value them equally• Another common denominator – Preferences are logically consistent, or transitive • When a consumer can make choices, and is logically consistent, we say that she has rational preferences• Rationality is a matter of how you make your choices, and not what choices you make – What matters is that you make logically consistent choices 12
    • More Is Better• We generally feel that more is better• The model of consumer choice is designed for preferences that satisfy the ―more is better‖ condition – It would have to be modified to take account of exceptions• The consumer will always choose a point on the budget line – Rather than a point below it 13
    • Theories• Theories of consumer decision making – Marginal utility – Indifference curve • Both assume that preferences are rational • Both assume that consumer would be better off with more of any good • Both theories come to same general conclusions about consumer behavior• Our goal is to describe and predict how consumers are likely to behave in markets – Rather than describe what actually goes on in their minds 14
    • Marginal Utility• Marginal utility of an additional unit – Change in utility derived from consuming an additional unit of a good• The law of diminishing marginal utility, as defined by Alfred Marshall (1842-1924) states that – Marginal utility of a thing to anyone diminishes with every increase in the amount of it he/she already has 15
    • Total And Marginal UtilityUtils 70 60 Total Utility 50 40 1. The change in total utility from 30 one more bottle . . . 20 10 1 2 3 4 5 6 Mogu-Mogu per Week 2. is called the marginal utility 3. Marginal utility fallsUtils of an additional bottle. as more bottles are 30 20 consumed. 10 Marginal Utility 1 2 3 4 5 6 Mogu-Mogu per Week 16
    • Budget Constraint and Preferences (Marginal Utility)• If we combine information about preferences (marginal utility values) with information about what is affordable (the budget constraint) – Can develop a useful rule to guide us to an individual’s utility-maximizing choice• Highest possible utility will be point at which marginal utility per PESO is the same for both goods 17
    • Consumer Decision MakingNumber of MU concerts MU moviesMovies per  40,  15 Month Pconcerts Pmovies 15 A MU concerts MU movies  20,  20 12 B Pconcerts Pmovies MU concerts MU movies 9 C  15,  35 Pconcerts Pmovies D 6 G E 3 F 1 2 3 4 5 Number of Concerts per Month 18
    • Budget Constraint and Preferences (Marginal Utility)• For any two goods x and y, with prices Px and PY, whenever MUx / Px > MUY / PY, a consumer is made better off shifting away from y and toward x – When MUY / PY > MUX / PX, a consumer is made better off by shifting spending away from x and toward y• Leads to an important conclusion – A utility-maximizing consumer will choose the point on the budget line where marginal utility per peso is the same for both goods (MUX / PX = MUY / PY) – At that point, there is no further gain from reallocating expenditures in either direction 19
    • Budget Constraint and Preferences (Marginal Utility)• No matter how many goods there are to choose from, when the consumer is doing as well as possible – It must be true that MUX / PX = MUY / PY for any pair of goods x and y – If this condition is not satisfied, consumer will be better off consuming more of one and less of the other good in the pair 20
    • Consumer Equilibrium• Occurs when the other housing consumer has spent education all income and the marginal utilities per entertain. peso spent on each food good purchased are recreation transport. equal.• MUA/PA=MUB/PB=MUC/PC =……………MUZ/PZ A B
    • Changes In Income• A rise in income—with no change in price—leads to a new quantity demanded for each good – Whether a particular good is normal (quantity demanded increases) or inferior (quantity demanded decreases) depends on the individual’s preferences • As represented by the marginal utilities for each good, at each point along the budget line 22
    • Effects of an Increase in Income Number of 30 2. If his preferences are as given Movies per 27 H in the table, hell choose point H Month1. When Iegos income rises to Php3000, his budget A line shifts 15 B outward. 12 H 3.But different marginal C utility numbers could 9 D lead him to H or H 6 E 3 H F 1 2 3 4 5 6 7 8 9 10 Number of Concerts per Month 23
    • Changes In Price• A drop in the price of concerts rotates the budget line rightward, pivoting around its vertical intercept• The consumer will select the combination of movies and concerts on his budget line that makes him as well off as possible – Will be combination at which marginal utility per dollar spent on both goods is the same 24
    • Deriving the Demand Curve 1. When the price of concerts is 2. If the price falls toNumber of 15 Php300, point D is best for Php100, IegosMovies per Iego. budget line rotates Month 10 K rightward, and he 8 choose point J. 6 D J 0 3 5 7 10 15 30 3. And if the price drops to Price per 30 Php50, he chooses D point K. Concert 4. The demand curve shows 10 J the quantity Iego chooses 5 K at each price. 3 7 10 Number of Concerts per Month 25
    • The Individual’s Demand Curve• Curve showing quantity of a good or service demanded by a particular individual at each different price• In theory, an individual’s demand curve could slope upward 26
    • Substitution Effect• Substitution effects – As the price of a good falls, the consumer substitutes that good in place of other goods whose prices have not changed• Substitution effect of a price change arises from a change in the relative price of a good – And it always moves quantity demanded in the opposite direction to the price change • When price decreases (increases), substitution effect works to increase (decrease) quantity demanded 27
    • Income Effect• Income effect – As price of a good decreases, the consumer’s purchasing power increases, causing a change in quantity demanded for the good• Income effect of a price change arises from a change in purchasing power over both goods – A drop (rise) in price increases (decreases) purchasing power• Income effect can work to either increase or decrease the quantity of a good demanded, depending on whether the good is normal or inferior 28
    • Combining Substitution and Income Effect• A change in the price of a good changes – Relative price of the good (the substitution effect) and – Overall purchasing power of the consumer (the income effect) 29
    • Normal Goods• Substitution and income effects work together – Causing quantity demanded to move in opposite direction of price • Normal goods must always obey law of demand 30
    • Inferior Goods• Substitution and income effects of a price change work against each other – Substitution effect moves quantity demanded in the opposite direction of the price – While income effect moves it in same direction of price – But since substitution effect virtually always dominates • Consumption of inferior goods will virtually always obey law of demand 31
    • AGAIN, Income and Substitution Effects Price Decrease: Ultimate EffectP Substitution Effect (Almost Always) QD  QD Purchasing QD if normal Power QD if inferior Price Increase:P Substitution Effect QD  QD Purchasing QD if normal Power QD if inferior 32
    • AGAIN, Utility• Total utility –Total satisfaction from a specific quantity• Marginal utility –Extra satisfaction from an additional unit• Law of diminishing marginal utility –Explains downward sloping demand 7-33
    • AGAIN,Utility Graphically Total Utility 30 Total Utility (Utils) (1) (2) (3) Tacos Total MarginalConsumed Utility, Utility, TU Per Meal Utils Utils 20 0 0 1 10 ] 10 10 2 18 ] 8 3 24 ] 6 0 1 2 3 4 5 6 7 Units Consumed Per Meal ] 4 Marginal Utility (Utils) 4 28 Marginal Utility 5 30 ] 2 10 6 30 ] 0 8 6 28 ] -2 4 7 2 0 -2 MU 1 2 3 4 5 6 7 Units Consumed Per Meal 7-34
    • AGAIN, Consumer Behavior• Key dimensions of the consumer problem –Rational behavior –Preferences –Budget constraint –Prices 7-35
    • AGAIN, Theory of Consumer Behavior• Find utility maximizing combination of goods• Utility maximizing rule –Allocate income –Last peso spent on each good yields same marginal utility –Marginal utility per peso 7-36
    • AGAIN, Numerical ExampleCombinations of apples and oranges obtainablewith an income of Php10 (2) (3) Apple (product A) Orange (product B) Price = 1 Price = 2 (b) (b) (a) Marginal (a) Marginal (1) Marginal Utility Marginal Utility Unit of Utility, Per Peso Utility, Per Peso Product Utils (MU/Price) Utils (MU/Price) First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Compare marginal utilities Fourth 6 6 16 8 Then compare per peso - MU/Price Fifth 5 5 12 6 Choose the highest 4 Sixth 4 6 3 Check budget - proceed to next item Seventh 3 3 4 2 7-37
    • Numerical ExampleCombinations of apples and oranges obtainablewith an income of Php10 (2) (3) Apple (product A) Orange (product B) Price = 1 Price = 2 (b) (b) (a) Marginal (a) Marginal (1) Marginal Utility Marginal Utility Unit of Utility, Per Peso Utility, Per Peso Product Utils (MU/Price) Utils (MU/Price) First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Again, compare per peso - MU/Price 8 Fourth 6 6 16 Choose the highest 5 Fifth 5 12 6 Buy one of each – budget has Php5 left3 Sixth 4 4 6 Proceed to next item3 Seventh 3 4 2 7-38
    • Numerical ExampleCombinations of apples and oranges obtainablewith an income of Php10 (2) (3) Apple (product A) Orange (product B) Price = 1 Price = 2 (b) (b) (a) Marginal (a) Marginal (1) Marginal Utility Marginal Utility Unit of Utility, Per Peso Utility, Per Peso Product Utils (MU/Price) Utils (MU/Price) First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8Again, compare per peso - MU/Price Fifth 5 5 12 6Buy one more orange – budget has Php3 left Sixth 4 4 6 3Proceed to next item 3 Seventh 3 4 2 7-39
    • Numerical ExampleCombinations of apples and oranges obtainablewith an income of Php10 (2) (3) Apple (product A) Orange (product B) Price = 1 Price = 2 (b) (b) (a) Marginal (a) Marginal (1) Marginal Utility Marginal Utility Unit of Utility, Per Peso Utility, Per Peso Product Utils (MU/Price) Utils (MU/Price)First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Again, compare per peso - MU/Price 3Sixth 4 4 6Buy one of each – budget exhausted 2Seventh 3 3 4 7-40
    • Numerical ExampleCombinations of apples and oranges obtainablewith an income of Php10 (2) (3) Apple (product A) Orange (product B) Price = 1 Price = 2 (b) (b) (a) Marginal (a) Marginal (1) Marginal Utility Marginal Utility Unit of Utility, Per Peso Utility, Per Peso Product Utils (MU/Price) Utils (MU/Price) First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Final result5 – at these prices, Fifth 5 12 6 Sixth 4 4 6 3 purchase 23 apples3 and 4 oranges 2 Seventh 4 7-41
    • Algebraic GeneralizationMU of product A MU of product B = price of B price of A 8 Utils 16 Utils Php1 = Php2Optimum Achieved – Money incomeis allocated so that the last peso spent on each product yields the same extra or marginal utility
    • Consumers in Markets• Since market demand curve tells us quantity of a good demanded by all consumers in a market – Can derive it by summing individual demand curves of every consumer in that market 43
    • From Individual To Market Demand Dan Alvir MarjPrice Price Price 4 4 4 3 3 3 2 c + 2 C + 2 C = 1 1 1 0 4 12 0 6 12 0 10 20 Number of Mogu-MoguBottles per Week 44
    • From Individual To Market DemandPrice A 4 B Market Demand 3 Curve C 2 D 1 E 3 10 27 44 Number of Mogu-Mogu Bottles per Week 45
    • Consumer Theory in Perspective: Extensions of the Model• Problems – The simple model ignores uncertainty – Imperfect information – People can spend more than their incomes in any given year by borrowing funds or spending out of savings• You might think consumer theory always regards people as relentlessly selfish – In fact, when people trade in impersonal markets, this is mostly true • People try to allocate their spending among different goods to achieve the greatest possible satisfaction 46
    • Who cares about this? (Beyond Econ Class in Pisay)• Companies, like P&G, realize that people have P&G Product Family limited budgets. They want to maximize consumer utility with THEIR products…. – Adjust product qualities to change utility to consumer. – Adjust prices• Methods – Focus groups – Test markets – Advertising – Packaging – Reformulations…
    • Limits to Utility Theory• Utility theory assumes people are: – Rational, self-interested, & consistent.• In recent years, many limitations to utility theory in economics have been noted by psychologists and economists. – These affect different kinds of transactions differently…. – Probably have little effect on buying and selling everyday things….
    • Inconsistent behavior?• Spite: In experiments, some people have been observed to spend money to reduce the money other people have won… – In a study, 62% of the participants made themselves worse off in order to make someone else worse off.• Compartmentalizing: People often treat money differently depending on the circumstances:• Endowment Effect: We value things we are endowed with more than things we don’t have… – Coffee mugs: 15 to sell; 10 to buy.