Introduction
Roger LeRoy Miller
Economics Today
Twelfth Edition
About one-third of U.S. federal income tax
returns are filed electronically.
Chapter 19
Consumer Choice
What factors determine the choice of software
for those who prepare their own return and
transmit it to the IRS electronically?
Copyright © 2004 Pearson Addison Wesley. All rights reserved.
Slide 19-2
Learning Objectives
Learning Objectives
Distinguish between total utility
and marginal utility
Discuss why marginal utility at first
rises but ultimately tends to decline
as a person consumes more of a good
or service
Slide 19-3
Explain why an individual’s optimal
choice of how much to consume of
each good or service entails equalizing
the marginal utility per dollar spent
across all goods and services
Describe the substitution effect
of a price change on the quantity
demanded of a good or service
Slide 19-4
1
Learning Objectives
Chapter Outline
Understand how the real-income effect
of a price change affects the quantity
of a good or service demanded
Evaluate why the price of diamonds
is so much higher than the price
of water even though people cannot
survive long without water
Utility Theory
Graphic Analysis
Diminishing Marginal Utility
Optimizing Consumption Choices
How a Price Change Affects Consumer
Optimum
The Demand Curve Revisited
Slide 19-5
Slide 19-6
Did You Know That...
Utility Theory
Online shoppers do not spend much
time comparing prices of the same
items at other Web sites?
A reduction in overall time spent
locating and selecting an item reduces
its cost?
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
Slide 19-7
Slide 19-8
2
Total and Marginal Utility
of Watching Videos
Utility Theory
Marginal Utility
– The change in total utility due to
a one-unit change in the quantity
of a good or service consumed
Marginal utility =
change in total utility
change in number of units consumed
Slide 19-9
Figure 19-1, Panel (a)
Slide 19-10
Total and Marginal Utility
of Watching Videos
Graphic Analysis
A graph can be used to display
the values displayed in the table
to better see their relationships.
Slide 19-11
Figure 19-1, Panel (b)
Slide 19-12
3
Total and Marginal Utility
of Watching Videos
Total and Marginal Utility
of Watching Videos
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
Slide 19-13
Total and Marginal Utility
of Watching Videos
6
4
2
0
-2
1
-4
1
2
3
4
5
6
DVDs Watched per Week
Figure 19-1, Panel (c)
8
Figure 19-1, Panels (b) and (c)
2
3
4
5
6
7
DVDs Watched per Week
7
…where marginal
utility equals zero.
Slide 19-14
Diminishing Marginal Utility
Observations
Diminishing Marginal Utility
– Marginal utility falls
– Marginal utility = 0 when total utility is at
its maximum
– 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
Slide 19-15
Slide 19-16
4
Newspaper Vending Machines versus
Candy Vending Machines
How many people take more than
one paper from the vending machine?
Why not dispense candy the same way?
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
Slide 19-17
Slide 19-18
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
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)
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
——
——
0
0.0
——
——
1
50.0
50.0
10.0
1
25
25
8.3
2
95.0
45.0
9.0
2
47
22
7.3
3
135.0
40.0
8.0
3
65
18
6.0
4
171.5
36.5
7.3
4
80
15
5.0
5
200.0
28.5
5.7
5
89
9
3.0
Slide 19-19
Slide 19-20
5
Total and Marginal Utility from Consuming
DVDs and Pizza Slices on an Income of $26
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
8.0
6.0
4
7.3
5.0
5
5.7
Choices
DVDs
7.3
3
Steps to Consumer Optimum
3.0
Pizza Slices
Purchase
Unit
(MUd/Pd)
Unit
1
First
10.0
First
8.3
2
Second
9.0
First
8.3
3
Third
8.0
First
8.3
4
Third
8.0
Second
7.3
5
Fourth
7.3
Second
7.3
Slide 19-21
Steps to Consumer Optimum
Buying Decision
First DVD
Remaining Income
$21 - $5 = $16
First pizza slice
$16 - $3 = $13
Third DVD
$13 - $5 = $ 8
Fourth DVD and
second pizza slice
Slide 19-22
Optimizing Consumption Choices
A little math
– The rule of equal marginal utilities
per dollar spent
$26 - $5 = $21
Second DVD
(Mup/Pp)
• 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
$8 - $5 = $ 3
$3 - $3 = $ 0
Slide 19-23
Slide 19-24
6
Optimizing Consumption Choices
How a Price Change
Affects Consumer Optimum
A little math
Income = $26
– The rule of equal marginal utilities per
dollar spent
MU of good B
MU of good A
MU of good Z
=
= ... =
price of good B
price of good A
price of good Z
Qd = 4
MUd
36.5
= 7.3
=
Pd
5
Qp = 2
MUp
22
=
Pp
3
= 7.3
Slide 19-25
Slide 19-26
How a Price Change
Affects Consumer Optimum
How a Price Change
Affects Consumer Optimum
Assume Price of DVDs Falls to $4
Assume Price of DVDs Falls to $4
Qd = 4
MUd
36.5
= 9.13
=
Pd
4
Qp = 2
MUp
22
=
Pp
3
= 7.3
Slide 19-27
Now
Result
MUd
MUp
>
Pd
Pp
Buy more DVDs
and MUd falls
Slide 19-28
7
DVD Rental Prices
and Marginal Utility
How a Price Change
Affects Consumer Optimum
Price per Unit ($ per DVD)
The Substitution Effect
– The tendency of people to substitute
cheaper commodities for more expensive
commodities
A
5
B
4
D
0
Figure 19-2
1
3
2
DVD Rentals per Week
Slide 19-29
How a Price Change
Affects Consumer Optimum
The Principle of Substitution
Slide 19-30
How a Price Change
Affects Consumer Optimum
Purchasing Power
– Consumers and producers shift away
from goods and resources that become
relatively higher priced in favor of goods
and resources that are now lower priced
Slide 19-31
– The value of money for buying goods and
services
Slide 19-32
8
How a Price Change
Affects Consumer Optimum
Real-Income Effect
How a Price Change
Affects Consumer Optimum
What do you think?
– The change in people’s purchasing power
that occurs when, other things being
constant, the price of one good that they
purchase changes
– Which would usually have more of an
impact, the substitution or the realincome effect?
Slide 19-33
Slide 19-34
The Demand Curve Revisited
The Demand Curve Revisited
Question
Marginal utility, total utility, and the
diamond-water paradox
– How is the demand curve derived?
– Water is essential to life but cheap
Answer
– By assuming income, tastes, expectations,
and the price of related goods are not
changing as the price and quantity
demanded of the good changes
Slide 19-35
– Diamonds are not essential to life but
expensive
Slide 19-36
9
The Diamond-Water Paradox
Price (dollars per kilogram)
Price (dollars per kilogram)
The Diamond-Water Paradox
Pdiamonds
Pwater
Ddiamonds
S2
Pdiamonds
Pwater
Dwater
Ddiamonds
Qdiamonds
Figure 19-3
Quantity per Period
(kilograms)
S1
Slide 19-37
Figure 19-3
Dwater
Qwater
Quantity per Period
(kilograms)
Slide 19-38
International Example:
The World of Water in Saudi Arabia
Issues and Applications: Consumer
Choice and Electronic Tax Filings
Water is five times more expensive
than gasoline in Saudi Arabia.
Tax preparation software packages vary
in price, depending on the features
offered.
Question
A taxpayer will be willing to pay a higher
price for a package that offers her a
higher marginal utility.
– How can we explain this reversal
of the U.S. prices?
Electronic filings are less error-prone.
Slide 19-39
Slide 19-40
10
Summary Discussion
of Learning Objectives
Web Links
The following Web link appears in the
margin of this chapter in the textbook:
– http://www.finfacts.ie/Private/win_rst/
w_mar24.htm
Total utility versus marginal utility
– Total utility is total satisfaction from consumption
– Marginal utility is the additional satisfaction from
consuming an additional unit of a good
Law of diminishing marginal utility
– Marginal utility eventually declines with additional
consumption
Slide 19-41
Summary Discussion
of Learning Objectives
Slide 19-42
Summary Discussion
of Learning Objectives
The substitution effect of a price
change
The real-income effect of a price change
– A person will substitute among goods by
buying less of a good when its price
increases
The consumer optimum
– Occurs when the marginal utility per dollar
spent on each good is the same
Slide 19-43
– A price change affects the purchasing power of a
person’s income
Why the price of diamonds exceeds
the price of water even though people
cannot long survive without water
– marginal utility determines how much people are
willing to buy
Slide 19-44
11
End of Chapter
Chapter 19
Consumer Choice
Copyright © 2004 Pearson Addison Wesley. All rights reserved.
12