A.P. Microeconomics

Household Choices

Take a few minutes to make your choices!!

Budget Constraints

Economists use economic models to illustrate budget constraints that consumers face. This consumer model is very similar to the production possibilities frontier of the producer!!

Example #1 Joel can spend $60 per month on normal

goods. His favorite perks to indulge in are: movies with a bucket of popcorn ($15) take-out meals ($10)

To figure out, you must determine Joel’s extremes. What is the most movies he can buy with his money or what is the most meals he can buy with his money?

# of Movies

# of Meals

6

4

Possible

Combinations

Impossible

Combinations

Example #2 Joel gets a raise at work and is able

to now spend $90 per month on his normal goods. Draw his new budget constraint.

# of Meals

# of Movies

9

6

Household Choices in Output Markets

1. The budget constraint determines the choice set that a particular household has available to it.

Wealth, income and the price of the product determine the choices that are actually affordable to the household.

This range of choices will expand or contract depending on changes in income or in the prices of products

Examples: Raise, inheritance, sell assets, etc.

2. Once the choice set is determined…

Utility is the amount of satisfaction derived from the consumption of a good or service when measured against other alternatives.

Impossible to measure realistically because it varies from person to person

2. Once the choice set is determined…

Marginal Utility is the amount of satisfaction derived from the consumption of an additional unit of the same good or service. This determines whether or not a consumer becomes a repeat customer of a firm. Firms want products with a high degree of marginal utility for each of their customers.

Examples: Brand Loyalty…you will come back for more because you liked the first one (PS2 to PS3, Apple Customers, etc)

Utility Maximization Rule

MUx = MUy For all pairs of goods

Px Py

How can I get the most satisfaction out of two choices?

We will use this rule and some math in a few minutes!!

Diminishing Marginal Utility is the simple fact that each time we consume

an additional unit of the same good or service, the amount of satisfaction we derive is reduced. Firms want to produce products for which their customers have low diminishing marginal utility.

Who wants a marshmallow?

Diminishing Marginal Utility

Examples: We tire of things!! We get full Too much of a good thing!!

The main point of all of this is that -

Analysis: how do we spend our time & money?

We compare options, weighing the costs and benefits!!

Utility Maximizing Rule

Let’s practice some examples and then you will get your homework.

Marginal Utility: the extra satisfaction you get from consuming an additional unit

Utils is what is used to measure units of utility.

When making a decision between two goods we can study the utils to decide which combination will give us the most satisfaction per dollar.

The Most Bang For Our Buck!!

Below is a chart for Lana’s pastry utility:

# of Pastri

es

Total Utility

Marginal Utility(MU)

1 12

2 22

3 28

4 32

5 34

6 34

7 33

12

10

6

4

2

0

-1

Price

P

$3

$3

$3

$3

$3

$3

$3

MU/P

This last box will measure how much

utility we get per dollar

4

3.33

2

1.33

.67

0

-

Analyzing the Chart

Assuming there are no price changes and no alternatives, how many pastries should Lana consume? Explain.

At most 5 pastries, any more would not give any extra marginal utility (MU)

Lana has to choose between pastries and lattes during a given period.

# of Lattes

TU MU Price MU/P

1 21 $6

2 33

3 42

4 48

5 51

6 51

7 49

21

12

9

6

30

-2

$6

$6

$6$6

$6

$6

3.521.51

.5

0-

Using the MU/P Columns

How many should Lana choose?

What is her perfect combination?

Utility Maximizing Rule:MUX MUY

PX PY

=

Compare Pastries & Lattes

Find where your MU/P columns are equal.

Or think through consuming one unit at a time…

Homework

Budget Constraints & Utility