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Consumer Choice Utility maximization. Do you shop incessantly? Did you ever have buyer’s remorse?. What makes you happy with a purchase? Do you consider yourself rational How do you define rational? Do you look at the marginal utility? What is diminishing marginal utility?
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Consumer Choice Utility maximization
Do you shop incessantly?Did you ever have buyer’s remorse? • What makes you happy with a purchase? • Do you consider yourself rational • How do you define rational? • Do you look at the marginal utility? • What is diminishing marginal utility? • What about MC = MB?
What is total utility? Total utility= amount of satisfaction obtained from entire consumption of a product. Willing to stay through all three acts of Le’ Miserable– great till the very last curtain call. 16 oz steak good to last bite. Watching 4 OT’s in a Hockey playoff.
Utility Theory • The more pleasure (satisfaction, utility) we get from a product, the higher the price we’re willing to pay for it. • Utility: the pleasure or satisfaction obtained from using a good or service. • Total utility: the amount of satisfaction obtained from the consumption of a series of products. • Marginal utility: the change in total utility obtained by consuming one additional (marginal) unit of a product.
Total and Marginal Utility of Downloading and Listening to Digital Music Albums, Panel (a)
TU and MU As more of a product is consumed, Total utility increases at a Diminishing rate.
TOTAL AND MARGINAL UTILITY TU Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 30 20 10 0 1 2 3 4 5 6 7 0 10 18 24 28 30 30 28 Total Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 Marginal Utility (utils) MU 1 2 3 4 5 6 7 Units consumed per meal
Observe Diminishing Marginal Utility TOTAL AND MARGINAL UTILITY TU Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 30 20 10 0 1 2 3 4 5 6 7 0 10 18 24 28 30 30 28 Total Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 Marginal Utility (utils) MU 1 2 3 4 5 6 7 Units consumed per meal
Utility Theory (cont'd) Observations Marginal utility falls as more is consumed. Marginal utility equals zero when total utility is at its maximum.
Diminishing Marginal Utility As long as marginal utility > 0, total utility increases. When marginal utility becomes negative, total utility maxes out and then decreases.
Diminishing Marginal Utility Law of Diminishing Marginal Utility = the marginal utility of a good declines as more of it is consumed in a given period of time. As long as MU is increasing TU must be increasing. When MU is not increasing (diminishing) each unit added yields less utility
Example: Newspaper Vending Machines versus Candy Vending Machines Newspaper machines do not prevent people from taking more than one paper. Why not dispense candy the same way? The answer is found in the concept of diminishing marginal utility. Can you think of a circumstance under which a substantial number of newspaper purchasers might be inclined to take more than one newspaper from a vending machine?
Consumer Optimum – Consumer Equilibrium A choice of a set of goods and services that maximizes the level of satisfaction for each consumer, subject to limited income Utility maximization – consumers want to get the most satisfaction from consumption choices Need to look at the concept of Marginal Utility per dollar spent
Optimizing Consumption ChoicesConsumer Equilibrium A consumer’s money income should be allocated so that the last dollar spent on each good purchased yields the same amount of marginal utility (when all income is spent), because this rule yields the largest possible total utility
A little math The rule of equal marginal utilities per dollar spent Optimizing Consumption Choices Consumer Equilibrium MU of good A MU of good B MU of good Z ... = = Price of good A Price of good B Price of good Z
Optimizing Consumption Choices Consumer Equilibrium 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
Total and Marginal Utility from Consuming Music Album Downloads ($5) and Cappuccinos ($3) on an Income of $26
Total and Marginal Utility from Consuming Music Album Downloads and Cappuccinos on an Income of $26
Price and Quantity • The demand curve slopes downward because of diminishing marginal utility. • In order to justify buying more, the price must be lower. • At $0.25, the consumer buys 12 ounces (point f).
Maximizing Utility How would you maximize your utility? Select that good which delivers the most marginal utility/dollar even for last dollar spent. (allocation of dollars example) Buying that new IPhone 5 is “worth it” even though it cost $500.00? Why would we buy it if it doesn’t bring some degree of satisfaction?
Let’s think of MU as MB Remember… If MC > MB should not produce. Criminal behavior – person stealing imposes uncompensated costs on others Person considering not stealing, but buying weighs the cost (price) and benefit (utility.) How could we reduce criminal activity to not create cost to society?
Theory of Consumer Behavior Theory of Rational Behavior Preferences Budget Constraints Prices Time (Time/value/money)
Total utility versus marginal utility Total utility is total satisfaction from consumption. Marginal utility is the additional satisfaction from consuming an additional unit. Law of diminishing marginal utility Marginal utility ultimately declines as a person consumes more and more of a good or service.
The consumer optimum Occurs when the marginal utility per dollar spent on the last unit consumed is equalized The substitution effect of a price change A person will substitute among goods by buying less of a good when its price increases.
Practice Set Coffee costs $.30/cup..If you behave according to consumer choice and In rational manner.. How many cups will you drink?
Time/Value/Money Assuming you want to derive total satisfaction for last dollar spent. Golf Outing = $30.00 Concert = $40.00 Both are equal in utility to you. Which would actually be more costly to indulge in? Golf takes 4 hours Concert approximately 2 hours
Other Important Info for Rational Utility Maximization Decision to be made How much do you make an hour? If you earn $10.00 an hour, golf game costs your $70.00… concert $60.00 How did you get this sum? (Golf = $30.00 Market place + $40.00 ) (Concert = $40.00 Market place + 20.00) Now you know in economic terms why driving all over Dallas to pick up “loss leaders” is costly. TIME IS MONEY!
Time/Value/Money Does the CEO do his own typing? • Does the doctor run around doing errands in search of bargains?
Remember.. SubstitutionWe have learned: That maximizing our utility is our goal. That our marginal utility decreases with each additional unit. That because of this the demand curve will be downward sloping We can also shift our demand curve to a substitute (assuming we can get equal utils of satisfaction.)
