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.

19-4

Total and Marginal Utility of Downloading and Listening to Digital Music Albums, Panel (a)

TU and MUTacos consumed in 1 meal

TU MU

0 0

1 10 10

2 18 8

3 24 6

4 28 4

5 30 2

6 30 0

7 28 -2

As more of a product is consumed, Total utility increases at aDiminishing rate.

TOTAL AND MARGINAL UTILITYTacos

consumedper meal

TotalUtility,Utils

MarginalUtility,Utils

01234567

010182428303028

10 8 6 4 2 0 -2

Units consumed per meal

Units consumed per meal

30

20

10

To

tal

Uti

lity

(u

tils

)M

arg

ina

l U

tili

ty (

uti

ls)

10 8 6 4 2 0 -2

TU

MU

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

TOTAL AND MARGINAL UTILITYTacos

consumedper meal

TotalUtility,Utils

MarginalUtility,Utils

01234567

010182428303028

10 8 6 4 2 0 -2

Units consumed per meal

Units consumed per meal

30

20

10

To

tal

Uti

lity

(u

tils

)M

arg

ina

l U

tili

ty (

uti

ls)

10 8 6 4 2 0 -2

TU

MU

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

ObserveDiminishingMarginalUtility

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.

19-10

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

Price of good A

=

MU of good B

Price of good B

MU of good Z

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

Steps to Consumer Equilibrium

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).

19-20

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 SetCups of Coffee

TC

TB

1x 30=.30 $3.00

2x 30 =.60 $2.00

3x 30 =.90 $1.00

4x 30 =1.20 $0.50

5x30 = 1.50 $0.10

6 $0.05

7 $0.00

Coffee costs $.30/cup..If you behave according to consumer choice and In rational manner.. How many cups will you drink?

MC

$.30

.30

.30

.30

Time/Value/Money

Assuming you want to derive total satisfaction for last dollar spent.

Golf Outing = $30.00Concert = $40.00Both are equal in utility to you.Which would actually be more costly to indulge in?Golf takes 4 hoursConcert 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 doctor run around doing errands in search of bargains?

Does the CEO do his own typing?

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.)

Last check on knowledge!

Units Consumed

TU MU

0 0

1 10 10

2 18 8

3 25 7

4 30 5

5 33 3

6 34 1

Units Consumed

TU MU

0 0

1 10 10

2 8

3 25

4 30

5 3

6 34

Kiley- Total Utility- Never diminishing