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Chapter 20

Chapter 20 Consumer Choice Cyberspace is challenging territory for those with visual impairments.

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Chapter 20

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  1. Chapter 20 Consumer Choice

  2. Cyberspace is challenging territory for those with visual impairments. Because internet shopping is more difficult for those with disabilities, economic theory says that this adds to the cost of internet purchases. As a result, disabled consumers may buy less frequently from web-based retailers. Introduction

  3. 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

  4. Learning Objectives • 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

  5. Learning Objectives • 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

  6. Chapter Outline • Utility Theory • Graphical Analysis • Diminishing Marginal Utility • Optimizing Consumption Choices • How a Price Change Affects Consumer Optimum • The Demand Curve Revisited

  7. Did You Know That... • The pace of product innovation for new consumer goods is about twice as high as it was 20 years ago? • The economic analysis of consumer choice provides a way to account for all the variables of taste, income, and prices as they relate to individual decisions?

  8. 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 utilityis measured

  9. change in total utility Marginal utility = change in number of units consumed Utility Theory • Marginal Utility • The change in total utility due to a one-unit change in the quantity of a good or service consumed

  10. Total and Marginal Utilityof Watching DVDs Figure 20-1, Panel (a)

  11. Graphical Analysis Figure 20-1, Panel (b)

  12. Graphical Analysis Figure 20-1, Panel (c)

  13. 20 18 10 16 8 14 6 12 Total Utility (utils per week) 10 4 Marginal Utility (utils per week) 8 2 6 0 1 2 3 4 5 6 7 4 -2 2 -4 DVDs Watched per Week 0 1 2 3 4 5 6 7 DVDs Watched per Week Figure 20-1, Panels (b) and (c) Total and Marginal Utilityof Watching DVDs Total utility is maximized... …where marginal utility equals zero.

  14. Total and Marginal Utilityof Watching Videos • Observations • Marginal utility falls as more is consumed • Marginal utility equals zero when total utility is at its maximum

  15. 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

  16. Example: Vending Machines • How many people take more than one paper from the vending machine? • Why not dispense candy the same way? • The answer is found is the concept of diminishing marginal utility.

  17. 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

  18. Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26 Total Utility Marginal Utility DVDs of DVDs per Marginal Utility per Dollar per Period (utils) Spent (MUd/Pd) Period (utils) MUd (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

  19. Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26 Total Utility Marginal Utility Pizza Slices of Pizza Slices Marginal Utility per Dollar per per Period (utils) Spent (MUpPp) Period (utils) MUp (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

  20. Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26 Marginal Utility Marginal Utility Items per Dollar per Dollar per Spent (DVD) Spent (Pizza) Period (price = $5) (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 Table 20-1

  21. Steps to Consumer Optimum Choices DVDs Pizza Slices Purchase Unit (MUd/Pd) Unit (Mup/Pp) 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 Table 20-2

  22. Steps to Consumer Optimum Buying Decision Remaining Income First DVD $26 - $5 = $21 Second DVD $21 - $5 = $16 First pizza slice $16 - $3 = $13 Third DVD $13 - $5 = $ 8 Fourth DVD and $8 - $5 = $ 3 second pizza slice $3 - $3 = $ 0 Table 20-2

  23. 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

  24. 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 • A little math • The rule of equal marginal utilities per dollar spent

  25. Qd = 4 Qp = 2 MUd MUp 22 36.5 = 7.3 = = 7.3 = 3 Pd Pp 5 How a Price ChangeAffects Consumer Optimum Income = $26

  26. Qd = 4 = 9.13 = Qp = 2 MUd MUp 22 36.5 = 7.3 = 3 Pd Pp 4 How a Price ChangeAffects Consumer Optimum Assume Price of DVDs Falls to $4

  27. Now > Result Buy more DVDs and MUd falls MUd MUp Pd Pp How a Price ChangeAffects Consumer Optimum Assume Price of DVDs Falls to $4

  28. A B D DVD Rental Pricesand Marginal Utility 5 Price per Unit ($ per DVD) 4 0 1 2 3 Figure 20-2 DVD Rentals per Week

  29. How a Price ChangeAffects Consumer Optimum • The Substitution Effect • The tendency of people to substitute cheaper commodities for more expensive commodities

  30. How a Price ChangeAffects Consumer Optimum • The Principle of Substitution • 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

  31. How a Price ChangeAffects Consumer Optimum • Purchasing Power • The value of money for buying goods and services

  32. How a Price ChangeAffects Consumer Optimum • 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 changes

  33. How a Price ChangeAffects Consumer Optimum • What do you think? • Which would usually have more of an impact on your purchases: the substitution effect or the real-income effect?

  34. The Demand Curve Revisited • Question • How is the demand curve derived? • Answer • By assuming income, tastes, expectations, and the price of related goods are not changing as the price of the good changes

  35. E-Commerce Example:Virtual 3D Pays Off at Lands’ End • The retailer Lands’ End provides shoppers with a 3D simulation of clothing items on a model with measurements customized to match those of the shopper. • Such a feature helps reduce the customer’s uncertainty. • Evidence collected so far indicates that Lands’ End shoppers are willing to pay higher prices for this feature.

  36. The Demand Curve Revisited • Marginal utility, total utility, and the diamond-water paradox • Water is essential to life but cheap • Diamonds are not essential to life but expensive

  37. Pdiamonds Pwater Ddiamonds Dwater The Diamond-Water Paradox Price (dollars per kilogram) Quantity per Period (kilograms) Figure 20-3

  38. S2 S1 Qdiamonds Qwater The Diamond-Water Paradox Pdiamonds Price (dollars per kilogram) Pwater Ddiamonds Dwater Quantity per Period (kilograms) Figure 20-3

  39. International Example:The World of Water in Saudi Arabia • Water is five times more expensive than gasoline in Saudi Arabia. • Question • How can we explain this reversal of the U.S. prices?

  40. Issues and Applications:Internet Shopping with Disabilities • Web pages are most easily used by those without visual impairments, especially because most are not accompanied by audio files to assist in navigation. • If you have difficulty navigating a website, then any purchase you make has an added cost.

  41. Issues and Applications:Internet Shopping with Disabilities • As more websites become better equipped with voice instructions, they will be more easily used by those who cannot navigate the site visually. • Already, the presence of more aids for the disabled has contributed to an increasing volume of internet commerce.

  42. Summary Discussionof Learning Objectives • 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

  43. Summary Discussion of Learning Objectives • The substitution 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

  44. Summary Discussion of Learning Objectives • The real-income effect of a price change • 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

  45. End of Chapter 20 Consumer Choice

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