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1、1 of 35WHAT YOU WILL LEARN IN THIS CHAPTERchapter: 102009 Worth PublishersThe Rational Consumer2 of 35WHAT YOU WILL LEARN IN THIS CHAPTERHow consumers choose to spend their income on goods and servicesWhy consumers make choices by maximizing utility, a measure of satisfaction from consumptionWhy the
2、 principle of diminishing marginal utility applies to the consumption of most goods and servicesHow to use marginal analysis to find the optimal consumption bundleWhat income and substitution effects are3 of 35Opportunity Cost and DecisionsThe utility of a consumer is a measure of the satisfaction t
3、he consumer derives from consumption of goods and services.An individuals consumption bundle is the collection of all the goods and services consumed by that individual.An individuals utility function gives the total utility generated by his or her consumption bundle. The unit of utility is a util.4
4、 of 351513119753110152839485560636463Total utility (utils)Marginal utility per clam (utils)0123456789Quantity of clamsUtility functionMarginal Utility Curve798654321070605040302010Total utility (utils)Quantity of clams79865432116141210864202Marginal utility per clams (utils)Quantity of clams(a)Cassi
5、es Utility Function(b)Cassies Marginal Utility CurveCassies Total Utility and Marginal Utility5 of 35Cassies Total Utility and Marginal UtilityCassies total utility depends on her consumption of fried clams. It increases until it reaches its maximum utility level of 64 utils at 8 clams consumed and
6、decreases after that.The marginal utility curve slopes downward due to diminishing marginal utility; each additional clam gives Cassie less utility than the previous clam.6 of 35Cassies Total Utility and Marginal UtilityNote that the 9th clam is “too much.”7 of 35The Principle of Diminishing Margina
7、l UtilityThe marginal utility of a good or service is the change in total utility generated by consuming one additional unit of that good or service. The marginal utility curve shows how marginal utility depends on the quantity of a good or service consumed.The principle of diminishing marginal util
8、ity says that each successive unit of a good or service consumed adds less to total utility than the previous unit.8 of 35FOR INQUIRING MINDSIs Marginal Utility Really Diminishing?Are all goods really subject to diminishing marginal utility? Of course not; there are a number of goods for which, at l
9、east over some range, marginal utility is surely increasing.Examples are:Downhill skiing, which involves more fear than enjoyment at the start, but then becomes pleasurable after its mastered.People who are not accustomed to drinking coffee find it bitter.If you need two rolls of wallpaper to finish
10、 a room, the marginal utility of the second roll is larger than that of the first roll.So why does it make sense to assume diminishing marginal utility? Most goods dont suffer from the above qualifications.In the relevant range of consumption, marginal utility is still diminishing.9 of 35ECONOMICS I
11、N ACTIONOysters versus ChickenIs a particular food a special treat, something you consume on special occasions? Or is it an ordinary, take-it-or-leave-it dish? The answer depends lot on how much of that food people normally consume, which determines how much utility they get at the margin from havin
12、g a bit more.Unlike today, chicken was a luxury dish because chickens were expensive to raise. Also, oysters were very cheap and abundant and were regarded as poverty food.However, the emergence of new, technologically-advanced methods of raising and processing the birds made chicken abundant and ch
13、eap, while pollution destroyed many oyster beds, reduced supply, and human population growth increased demand.As such, oysters went from being common food to a luxury good while chicken took the reverse.10 of 35Budgets and Optimal ConsumptionA budget constraint requires that the cost of a consumers
14、consumption bundle be no more than the consumers total income.A consumers consumption possibilities is the set of all consumption bundles that can be consumed given the consumers income and prevailing prices.A consumers budget line shows the consumption bundles available to a consumer who spends all
15、 of his or her income.11 of 35102345108642ABCDEFAffordable consumption bundles that cost all of Sammys incomeSammys Budget Line, BLAffordable consumption bundlesUnaffordable consumption bundlesQuantity of clams (pounds)Quantity of potatoes (pounds)ABCDEFConsumption bundle012345Quantity of clams(poun
16、ds)1086420Quantity of potatoes(pounds)The budget line represents all the possible combinations of quantities of potatoes and clams that Sammy can purchase if he spends all of his income. It is also the boundary between the set of affordable consumption bundles (the consumption possibilities) and una
17、ffordable ones.The Budget Line12 of 35Sammys Utility from Clam and Potato Consumption13 of 35Optimal Consumption ChoiceThe optimal consumption bundle is the consumption bundle that maximizes a consumers total utility given his or her budget constraint.14 of 35Sammys Budget and Total UtilitySammys to
18、tal utility is the sum of the utility he gets from clams and the utility he gets from potatoes.15 of 35Quantity of potatoes (pounds)543210108642AABBCCDDEEBLUtility functionFF5432108070605040302010Quantity of clams (pounds)0246810(a) Sammys Budget Line(b) Sammys Utility FunctionThe optimal consumptio
19、n bundleQuantity of clams (pounds)Quantity of potatoes (pounds) maximizes total utility given the budget constraintTotal utility (utils)Optimal Consumption BundleSammys total utility is maximized at bundle C, where he consumes 2 pounds of clams and 6 pounds of potatoes. This is Sammys optimal consum
20、ption bundle.16 of 35FOR INQUIRING MINDSFood for Thought on Budget ConstraintsBudget constraints arent just about money. In fact, there are many other budget constraints affecting our lives.Examples are:Limited amount of closet space for clothes.A fixed number of hours in a day.A dieter on the Weigh
21、t Watchers plan is only allowed a maximum number of points regarding the food they can eat each day whereby each food is assigned a certain number of points.The dieter is just like a consumer choosing a consumption bundle: points are the equivalent of prices, and the overall point limit is the equiv
22、alent of total income.17 of 35ECONOMICS IN ACTIONThe Consumption Possibilities of American Workers,1895-2000Over the past century, the consumption possibilities of the average American worker have increased radically as the nation has become vastly richer.According to Economist DeLong,In 1895, an av
23、erage workers annual income would have bought 7.7 one-speed bicycles; in 2000, it would have bought 278 bicycles.In 1895, the workers annual income would have bought 45 full sets of dinner plates; in 2000, it would have bought 556 sets.In 1895, an average workers annual income would have bought 0.83
24、 of a Steinway piano; in 2000, it would have bought 1.8 pianos.By any standard, the average Americans consumption possibilities have increased enormously.18 of 35Spending the Marginal DollarThe marginal utility per dollar spent on a good or service is the additional utility from spending one more do
25、llar on that good or service.19 of 35Sammys Marginal Utility per Dollar20 of 35Marginal Utility per DollarIf Sammy has, in fact, chosen his optimal consumption bundle, his marginal utility per dollar spent on clams and potatoes must be equal.654321BCBPMUC/PCMUP/PPC5432100246810Total utility (utils)Q
26、uantity of clams (pounds)Quantity of potatoes (pounds)At the optimal consumption bundle, the marginal utility per dollar spent on clams is equal to the marginal utility per dollar spent on potatoes.21 of 35PITFALLSThe Right Marginal ComparisonMarginal analysis solves “how much” decisions by setting
27、the marginal benefit of some activity equal to its marginal cost. In consumption decisions, unlike production decisions, theres a budget constraint which must be accounted for when doing marginal analysis.The right answer for marginal decisions involving consumption is that the marginal utility per
28、dollar spent on each good must be the same at the optimal consumption bundle. By factoring in prices, this comparison takes into account the fact that a consumer has a limited amount of money to spend.22 of 35Optimal Consumption RuleThe optimal consumption rule says that when a consumer maximizes ut
29、ility, the marginal utility per dollar spent must be the same for all goods and services in the consumption bundle.23 of 35FOR INQUIRING MINDSBut Are Consumers Really Rational?Many companies offer retirement plans for their employees, such as the 401(k), which save the worker thousands of dollars in
30、 taxes each year. However, some plans invest these savings in their own stock and when the company goes under, the employees lose their savings, e.g., Enron, Bear Stearns.Employees should compare the marginal utility of a dollar spent on current consumption with the marginal utility of a dollar save
31、d for retirement. They should weigh the tax advantages of saving through the employer plan against the risks of letting the employment decide where savings are invested.24 of 35FOR INQUIRING MINDSBut Are Consumers Really Rational?But recent economic research suggests that most people arent careful a
32、bout these issues.As the National Bureau of Economic Research puts it, workers seem to follow the path of least resistance, instead of comparing their options and maximizing their utility.Behavioral economists question the whole concept of the rational consumer. Their research focuses on situations
33、in which people dont seem to be rationalthat is, when they behave in ways that cant be easily explained by utility maximization.25 of 35ECONOMICS IN ACTIONBuying Your Way Out of TemptationIt might seem odd to pay more to get less. But snack food companies have discovered that consumers are indeed wi
34、lling to pay more for smaller portions, and exploiting this trend is a recipe for success.Small packages are popular because they help consumers eat less without having to count calories themselves.The extra utility gained from not having to worry about whether theyve eaten too much is worth the ext
35、ra cost.Consumers are being rational: in addition to their snack, theyre buying a little hand-to-mouth restraint.26 of 35From Utility to the Demand CurveThe main reason for studying consumer behavior is to go behind the market demand curveto understand how the downward slope of the market demand cur
36、ve is explained by the utility-maximizing behavior of individual consumers.27 of 35Marginal Utility, the Substitution Effect, and the Law of DemandThe substitution effect of a change in the price of a good is the change in the quantity consumed of that good as the consumer substitutes the good that
37、has become relatively cheaper for the good that has become relatively more expensive.28 of 35The Income EffectThe income effect of a change in the price of a good is the change in the quantity consumed of that good that results from a change in the consumers purchasing power due to the change in the
38、 price of the good.Normal GoodsInferior GoodsGiffen Goods29 of 35FOR INQUIRING MINDSGiffen GoodsBack when Ireland was a desperately poor countrynot the prosperous “Celtic Tiger” it has lately becomeit was claimed that the Irish would eat more potatoes when the price of potatoes went up. That is, som
39、e observers claimed that Irelands demand curve for potatoes sloped upward, not downward.Suppose that there is a good that absorbs a large share of consumers budgets and that this good is also inferiorpeople demand less of it when their income rises.Suppose the price of the good, say potatoes, increa
40、ses. This would, other things equal, cause people to substitute other goods for potatoes. But other things are not equal: given the higher price of potatoes, people are poorer. This increases the demand for potatoes because potatoes are an inferior good.30 of 35ECONOMICS IN ACTION Mortgage Rates and
41、 Consumer DemandMost people buy houses with mortgagesloans backed by the value of the house. The interest rates of such change over time.For example, they fell quite a lot between 2000 and 2003.When mortgage rates fall, the cost of housing falls and the demand for housing goes up as even people who
42、have mortgages at high rates are able to refinance them at lower rates.Economists have noticed that when this happens, the demand for other goods also rises, such as furniture, cars, more vacation time etc. WHY?31 of 35ECONOMICS IN ACTION Mortgage Rates and Consumer DemandWhen housing is cheaper, th
43、ere is a substitution effect: people have an incentive to substitute housing in place of other goods in their consumption bundle.So when house prices fall, people are in effect richerthere is a noticeable income effect. So people buy more of the other goods in addition to the houses that they buy.32
44、 of 35SUMMARY1.Consumers maximize a measure of satisfaction called utility. Each consumer has a utility function that determines the level of total utility generated by his or her consumption bundle, the goods and services that are consumed.2.A goods or services marginal utility is the additional ut
45、ility generated by consuming one more unit of the good or service. We usually assume that the principle of diminishing marginal utility holds: consumption of another unit of a good or service yields less additional utility than the previous unit.33 of 35SUMMARY3.A budget constraint limits a consumer
46、s spending to no more than his or her income. It defines the consumers consumption possibilities, the set of all affordable consumption bundles. A consumer who spends all of his or her income will choose a consumption bundle on the budget line. An individual chooses the consumption bundle that maxim
47、izes total utility, the optimal consumption bundle.4.The optimal consumption rule says that at the optimal consumption bundle the marginal utility per dollar spent on each good and servicethe marginal utility of a good divided by its priceis the same.34 of 35SUMMARY5.Changes in the price of a good a
48、ffect the quantity consumed in two possible ways: the substitution effect and the income effect. For normal goods, the substitution and income effects reinforce each other. For inferior goods, however, they work in opposite directions.35 of 35The End of Chapter 10Coming attraction:Chapter 11: Customer Preferences and Consumer Choice
