chapter 21 – consumer theory and utility maximization i.the income effect a. a change in price...

Chapter 21 – Consumer Theory and Utility Maximization

I. The Income EffectA. A change in price affects consumers’ real income.B. This change in real income affects the consumer’s ability to buy all sorts of products, not just the one for which the price changed.C. Demand for all normal goods will increase when the price of any other good goes down (and vice versa).D. Demand for inferior goods will increase when the price of any other good goes up (and vice versa).

Chapter 21 – Consumer Theory and Utility Maximization

II. The Substitution EffectA. A change in price makes a good relatively more expensive or less expensive than other goods.B. If price goes up, consumers will switch purchases to other goods.C. If price goes down, consumers will switch from other goods and buy more of the good.D. The substitution effect and the income effect combine when prices change to affect consumer behavior.E. *Quirky weirdness about inferior goods.

The Law of Diminishing Marginal Utility

I. As a consumer consumes more of a good, the satisfaction he or she gets from each additional unit decreases.

II. The more of a good you consume, the less you will want the next unit.

The Income Effect, the Substitution Effect, and the Law of Diminishing Marginal Utility all explain why the demand curve slopes downward.

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The Law of Diminishing Marginal Utility

I. Total Utility: the total satisfaction you get from consuming a specific quantity of a good (e.g. 5 cheeseburgers).

II. Marginal Utility: the amount of satisfaction you get from consuming one additional unit (the next cheeseburger).

III. See the graphs on the next slide. This relationship between total utility and marginal utility is key for the rest of the course.

The Utility-Maximizing Rule

I. To maximize satisfaction, a consumer should spend his money so that the last dollar spent on each good provides the same amount of marginal utility.

Quantity

Total Utility

Marginal

Utility

Marginal Utility Per $

Quantity

Total Utility

Marginal

Utility


0 0 0 0

1 400 1 325

2 700 2 600

3 900 3 825

4 1,000 4 1000

Cal Cool has $250 to spend on cell phones and sunglasses. The table below presents the utility from cell phones and sunglasses that Cal gets from quantities of each.

a. Calculate Cal’s marginal utility for cell phones.

b. Calculate Cal’s marginal utility for sunglasses.

Cell Phones Sunglasses

Quantity

Total Utility

Marginal

Utility


Quantity

Total Utility

Marginal

Utility


0 0 0 0 0 0 0 0

1 400 400 1 325 325

2 700 300 2 600 275

3 900 200 3 825 225

4 1,000 100 4 1000 175


a. Calculate Cal’s marginal utility for cell phones.

b. Calculate Cal’s marginal utility for sunglasses.


Quantity

Total Utility

Marginal

Utility


Quantity

Total Utility

Marginal

Utility


0 0 0 0 0 0 0 0

1 400 400 4 1 325 325 6.5

2 700 300 3 2 600 275 5.5

3 900 200 2 3 825 225 4.5

4 1,000 100 1 4 1000 175 3.5


c. The price of cell phones is $100 and a pair of sunglasses is $50. Determine the consumption bundle of cell phones and sunglasses that maximizes Cal’s utility.


Quantity

Total Utility

Marginal

Utility


Quantity

Total Utility

Marginal

Utility


0 0 0 0 0 0 0 0

1 400 400 4 1 325 325 6.5

2 700 300 3 2 600 275 5.5

3 900 200 2 3 825 225 4.5 4 1,000 100 1 4 1000 175 3.5


c. The price of cell phones is $100 and a pair of sunglasses is $50. Determine the consumption bundle of cell phones and sunglasses that maximizes Cal’s utility.


Homework

• Read Chapter 21, p. 372- 379.• Do Study Question #5.

Snacks (Price = $4) Drinks (Price = $2)

QuantityTotal

UtilityMarginal

Utility

Marginal Utility

per Dollar

QuantityTotal

UtilityMarginal

Utility

Marginal Utility

per Dollar

1 15 1 122 25 2 213 31 3 294 34 4 365 36 5 42 6 47 7 50 8 52

$20 to spend.


QuantityTotal

UtilityMarginal

Utility

Marginal Utility

per Dollar

QuantityTotal

UtilityMarginal

Utility

Marginal Utility

per Dollar

1 15 15 1 12 122 25 10 2 21 93 31 6 3 29 84 34 3 4 36 75 36 2 5 42 6 6 47 5 7 50 3 8 52 2

$20 to spend.


QuantityTotal

UtilityMarginal

Utility

Marginal Utility

per Dollar

QuantityTotal

UtilityMarginal

Utility

Marginal Utility

per Dollar

1 15 15 3.75 1 12 12 62 25 10 2.5 2 21 9 4.53 31 6 1.5 3 29 8 44 34 3 .75 4 36 7 3.55 36 2 .5 5 42 6 3 6 47 5 2.5 7 50 3 1.5 8 52 2 1

$20 to spend.

Quantity of Chicken Wings

Marginal Utility of Chicken Wings

Units of Doughnuts Marginal Utility of Doughnuts

1 10 1 42 9 2 3.53 8 3 34 7 4 2.55 6 5 26 5 6 1.57 4.5 7 18 4 8 .5

Chicken Wings cost $2Doughnuts cost $1$10 to spend.

Quantity of Chicken Wings

Marginal Utility of Chicken Wings

Quantity of Doughnuts

Marginal Utility of Doughnuts

1 10 1 42 9 2 3.53 8 3 34 7 4 2.55 6 5 26 5 6 1.57 4.5 7 18 4 8 .5

Chicken Wings cost $2Doughnuts cost $1$10 to spend.

Excise TaxesHere’s what you need to know:1. What will the new equilibrium price and quantity

be?2. How much of the tax will consumers and producers

each pay?3. What will be the price buyers are actually paying?4. What will be the price sellers are actually getting?5. How much tax revenue will be collected?6. How much will deadweight loss be?7. What happens to consumer and producer surplus?

What’s Left – your questions?Anyone have any questions from this FRQ?FRQ - Movie Tickets

chapter 21 – consumer theory and utility maximization i.the income effect a. a change in price...

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