- 1. Lecture 2 September 10, 2013 1Hellen A. Seshie-Nasser
2. Consumer Choice Marginal Utility Theory Consumer surplus
Budget Constraints Indifference Curve Theory Revealed Preference
Theory September 10, 2013 2Hellen A. Seshie-Nasser 3. Consumer
Choice Todays lecture will cover Marginal Utility Theory Consumer
surplus Budget Constraints September 10, 2013 3Hellen A.
Seshie-Nasser 4. I. Marginal Utility Theory what is UTILITY?
benefit you get from consuming a good determined by your
tastes/preferences (assuming these are stable) The value a consumer
places on a unit of a good or service depends on the pleasure or
satisfaction he or she expects to derive from having or consuming
it at the point of making a consumption (consumer) choice.
September 10, 2013 4Hellen A. Seshie-Nasser 5. Total utility (TU)
total benefit from consuming good example total benefit from 3
biscuits/cookies September 10, 2013 5Hellen A. Seshie-Nasser 6. TU
increases as consumption increases, to a point < TU 2 cookies TU
3 cookies September 10, 2013 6Hellen A. Seshie-Nasser 7. Marginal
utility (MU) MU is the change in TU from consuming one more of a
good example how much MORE utility from an additional mobile phone?
September 10, 2013 7Hellen A. Seshie-Nasser 8. change in TU from 0
to 1 biscuit/cookie change in TU from 1 cookie to 2 cookies MU of
1st Biscuit/ cookie MU of 2nd cookie = = 0 September 10, 2013
8Hellen A. Seshie-Nasser 9. Diminishing marginal utility MU falls
as consumption rises You get sick of biscuits as you each more of
it. The more kenkey you consume the less youll want to each eat it.
September 10, 2013 9Hellen A. Seshie-Nasser 10. MU of 1st cookie
> MU of 2nd cookie 0 September 10, 2013 10Hellen A.
Seshie-Nasser 11. TU cookie TU rises at slower and slower rate as
MU declines MU cookie September 10, 2013 11Hellen A. Seshie-Nasser
12. Consumer Equilibrium: How to maximize TU? Equalize MU to price
of the good (single good case) equalize MU/price across goods
(Multiple goods case) The real case use available budget September
10, 2013 12Hellen A. Seshie-Nasser 13. Consumer equilibrium Balls
of kenkey Total Utility (in utils) Marginal Utility/Benefit 0 0 0 1
8 8 2 14 6 3 19 5 4 23 4 5 25 2 6 26 1 7 26 0 8 24 -2 How many
balls of kenkey would you buy if the price per ball was Gh1?
Marginal Cost Gh1 Gh1 Gh1 Gh1 Gh1 Gh1 Gh1 Gh1 Gh1 13September 10,
2013 Hellen A. Seshie-Nasser 14. Marginal utility = Price MUx =Px
Chose combination of kenkey and phone units where price of kenkey
price of phone units MU kenkey = MU phone units September 10, 2013
14Hellen A. Seshie-Nasser 15. why? Chose 6 balls of kenkey, one
1-cedit worth of phone credit suppose MU/Gh1 of cookies = 4, MU/Gh1
of Phone units = 15 by consuming fewer balls of kenkey and more
phone credits You would add more to my TU September 10, 2013
15Hellen A. Seshie-Nasser 16. Utility Maximizing Rule The consumers
money should be spent so that the marginal utility per dollar of
each goods equal each other. MUx = MUy 16 Px Py September 10, 2013
Hellen A. Seshie-Nasser Thus, the utility maximizing rule assumes
that you always consume where MU/P for each product is equal 17.
September 10, 2013 Hellen A. Seshie-Nasser 17 Assume apples cost $1
each and oranges cost $2 each. (If the consumer has $7), identify
the combination that maximizes utility. Example 18. TU vs. MU: The
Paradox of Value Diamond-Water paradox Gh10,000 for example can be
used to purchase either one carat diamond Or 5 million gallons of
tap water September 10, 2013 18Hellen A. Seshie-Nasser 19. why? TU
of water is greater than TU of diamonds water is essential for life
BUT water is abundant, diamonds are rarer MU of last diamond is
higher MU determines value When diamonds are scarce and drinking
water is abundant, marginal utility of a diamond ring is much
higher than the marginal utility of water. Although the total
utility of water may be greater than that of diamond rings.
September 10, 2013 19Hellen A. Seshie-Nasser 20. Stranded on a
desert island with no water, one may be happy, though, to trade his
diamond ring for a bottle of drinking water. Under such conditions,
the marginal utility of water must be greater that that of a
diamond ring. September 10, 2013 Hellen A. Seshie-Nasser 20 21. MU
and demand MU declines as consumption rises Price = MU willingness
to pay is less for each additional unit Hence downward sloping
demand The more consumed the less willingness to pay, hence the
lesser price offered for the product. September 10, 2013 21Hellen
A. Seshie-Nasser 22. example : balls of kenkey P Q D Gh1.0 4 balls
for 4th ball of kenkey willing to pay Gh1. for 2nd ball of
kenkeyGh1.5 2 balls willing to pay Gh1.5 September 10, 2013
22Hellen A. Seshie-Nasser 23. II. Consumer Surplus It is the
difference between what you pay for a good and what you are WILLING
to pay for the good Example: market price of a ball of kenkey =
Gh1.0 your marginal value of the 3rd ball is = Gh12 Your consumer
surplus then is = Gh2 September 10, 2013 23Hellen A. Seshie-Nasser
24. P Q D $10 The demand curve $12 3 your consumer surplus
September 10, 2013 24Hellen A. Seshie-Nasser 25. P Q D Gh1.0 10,000
total consumer surplus area between D and price of kenkey September
10, 2013 25Hellen A. Seshie-Nasser 26. III. The Budget Line A
budget constraint is a constraint on how much money (income,
wealth) an economic agent can spend on goods. We denote the amount
of available income by M given: consumers budget prices draw a line
representing choices consumption possibilities September 10, 2013
26Hellen A. Seshie-Nasser 27. example 2 goods: bread & kenkey A
loaf of bread = Gh1.0 A ball of kenkey = Gh0.5 daily budget = Gh4.0
September 10, 2013 27Hellen A. Seshie-Nasser 28. Possible
Combinations kenkey bread 0 2 4 6 8 4 3 2 1 0 September 10, 2013
28Hellen A. Seshie-Nasser 29. budget line Bread Kenkey 8 4 2 6 0
421 3 September 10, 2013 29Hellen A. Seshie-Nasser 30. budget line
Bread kenkey 8 4 2 6 0 421 3 Affordable Unaffordable September 10,
2013 30Hellen A. Seshie-Nasser 31. Mathematically Let Px= price of
good X Py = price of good Y M = Income of the consumer Assuming the
consumer spends all his/her income on only two goods, X and Y Then
the budget equation is given by; Px + Py = M September 10, 2013
Hellen A. Seshie-Nasser 31 32. Changes in Money Income Changes in
the consumers income budget line shifts Increases in income shift
the budget line outward away from the origin, and vice versa
suppose a consumer income changes from Gh5 to Gh4 September 10,
2013 32Hellen A. Seshie-Nasser 33. bread kenkey budget = Gh4 budget
= Gh5 8 4 2 6 0 10 421 3 5 September 10, 2013 33Hellen A.
Seshie-Nasser 34. Changes in Relative prices Changes in one price,
holding other prices and income constant; changes slope of budget
line Suppose price of kenkey rises from Gh.5 to Gh1.0 September 10,
2013 34Hellen A. Seshie-Nasser 35. Changes in Relative prices bread
kenkey 8 4 2 6 0 421 3 kenkey = $.50 kenkey = $1 September 10, 2013
35Hellen A. Seshie-Nasser 36. Changes in Relative prices Changes in
the prices of goods lead to changes in the real income of the
consumer. He therefore buys less of one or both goods. He can
choose to buy less amount of the relatively expensive good and more
or the same quantity of the relatively cheap good Or the same
quantity of the relatively expensive good and less of the
relatively expensive good. September 10, 2013 36Hellen A.
Seshie-Nasser 37. Exercise Assume apples cost $1 each and oranges
cost $2 each. If the consumer has $7, identify the combination that
maximizes utility. Find the quantities of apple and oranges the
consumer will purchase if a. Price of oranges falls to $1 b. Income
of the consumer increases to $10 c. Price of apples rises to $1.5
September 10, 2013 37Hellen A. Seshie-Nasser 38. sum it up consumer
decisions are based on preferences budget constraint consumer
decisions are made at the margin marginal benefit of one more
compared to price of one more September 10, 2013 38Hellen A.
Seshie-Nasser
