CURSO: INGLES TCNICO

10ma Lectura
Docente: Dr. Polan F. Ferr Gonzales
CONSUMER CHOICE
How Much of What You Like Should You Buy?1
According to the United States Bureau of Labor Statistics, in 2010 there were about 121
million households in the United States. The average household had before-tax annual income of
about $62,500. Consumers in these households faced many decisions. How much should they spend
out of their income, and how much should they save? On average, they spent about $48,100. They
also had to decide how to divide their expenditures among various types of goods and services,
including food, housing, clothing, transportation, health care, entertainment, and other items.

Of course, the average values of Table 1 U.S. Average Expenditures by Household, 2010
statistics reported for all households mask
the great variations in consumption
patterns by age, location, income level,
marital status, and family composition.
Table 1 compares expenditure patterns for
all households and for selected levels of
income.
A casual examination of the table
reveals some interesting patterns in
consumption. Consumers with lower
income tend to spend more than their
current after-tax income, electing to
borrow today and repay their loans in the
future. For example, households with
incomes in the $20,000$30,000 range
spend about $4,000 per year more than their after-tax income. By contrast, households with incomes
in excess of $70,000 save more than 30 percent their after-tax income. The table also indicates that
consumers who attend college can expect to earn substantially higher incomes, a fact that influences
the choice to attend college.
Consumer decisions have a profound impact on the economy as a whole and on the fortunes
of individual firms and institutions. For example, consumer expenditures on transportation affect the
financial viability of the airline and automobile sectors of the economy, as well as the demand for
related items such as fuel and insurance. The level of spending on health care will affect not only
providers of health care services in the private sector, but also the need for public sector programs
such as Medicare and Medicaid.
This lecture develops the theory of consumer choice, explaining how consumers allocate
their limited incomes among available goods and services. It begins where the last lecture left off. In
that lecture, we developed the first building block in the study of consumer choice: consumer
preferences. However, preferences alone do not explain why consumers make the choices they do.
Consumer preferences tell us whether a consumer likes one particular basket of goods and services
better than another, assuming that all baskets could be purchased at no cost. But it does cost the
consumer something to purchase baskets of goods and services, and a consumer has limited resources
with which to make these purchases.

VOCABULARY

An indifference curve is a line that shows all the consumption bundles that yield the same amount of
total utility for an individual.
The entire utility function of an individual can be represented by an indifference curve map, a collection
of indifference curves in which each curve corresponds to a different level of total utility.
The marginal rate of substitution, or MRS, of good R in place of good M is equal to MU R /MUM, the
ratio of the marginal utility of R to the marginal utility of M.

1 Material extrado y adaptado de la Bibliografa citada en el Silabo del curso.

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 CURSO: INGLES TCNICO
10ma Lectura
Docente: Dr. Polan F. Ferr Gonzales
The principle of diminishing marginal rate of substitution states that the more of good R a person
consumes in proportion to good M, the less M he or she is willing to substitute in place of another unit of
R.
Two goods, R and M, are ordinary goods in a consumers utility function when (1) the consumer requires
additional units of R to compensate for less M, and vice versa; and (2) the consumer experiences a
diminishing marginal rate of substitution in substituting one good for another.
The tangency condition between the indifference curve and the budget line holds when the indifference
curve and the budget line just touch. This condition determines the optimal consumption bundle when
the indifference curves have the typical convex shape.
The relative price of good R in terms of good M is equal to PR /PM.
The relative price rule says that at the optimal consumption bundle, the marginal rate of substitution of
one good in place of another is equal to the relative price.
Two goods are perfect substitutes if the marginal rate of substitution of one good in place of the other
good is constant, regardless of how much of each an individual consumes.
Two goods are perfect complements when a consumer wants to consume the goods in the same ratio
regardless of their relative price.

CHECK YOUR UNDERSTANDING

1. Julie has preferences for food F and clothing C described by a utility function U(F, C) = FC. Her
marginal utilities are MUF=C and MUC=F. Suppose that food costs $1 a unit and that clothing
costs $2 a unit. Julie has $12 to spend on food and clothing.
a. Using algebra (the tangency condition and the budget line), find the optimal choice of food
and clothing.
b. On a graph draw indifference curves corresponding to u=12, u=18, and u=24. Let the amount
of food be on the horizontal axis and the amount of clothing be on the vertical axis.
c. What is the marginal rate of substitution of food for clothing at her optimal basket? Show this
graphically and algebraically.
d. Suppose Julie decides to buy 4 units of food and 4 units of clothing with her $12 budget
(instead of the optimal basket).Would her marginal utility per dollar spent on food be greater
than or less than her marginal utility per dollar spent on clothing? What does this tell you about
how she should substitute food for clothing if she wanted to increase her utility without
spending any more money?

2. The utility that Ann receives by consuming food F and clothing C is given by U(F, C)=FC+F.
The marginal utilities of food and clothing are MUF=C+1 and MUC=F. Food costs $1 a unit, and
clothing costs $2 a unit. Anns income is $22.
a. Ann is currently spending all of her income. She is buying 8 units of food. How many units of
clothing is she consuming?
b. Graph her budget line. Place the number of units of clothing on the vertical axis and the
number of units of food on the horizontal axis. Plot her current consumption basket.
c. Draw the indifference curve associated with a utility level of 36 and the indifference curve
associated with a utility level of 72. Are the indifference curves bowed in toward the origin?
d. Using algebra, find the utility-maximizing choice of food and clothing.
e. What is the marginal rate of substitution of food for clothing when utility is maximized? Show
this graphically and algebraically.
f. Does Ann have a diminishing marginal rate of substitution of food for clothing? Show this
graphically and algebraically.

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