Consumer

Behavior and
Choice
 Utility
The satisfaction, or
reward, a product yields
relative to its alternatives.
The basis of choice.
The Law of Diminishing
Marginal Utility
The more of any one good
consumed in a given period, the
less satisfaction (utility)
generated by consuming each
additional (marginal) unit of the
same good.
 Marginal and Total Utility
Marginal Utility (MU) The additional
satisfaction gained by the consumption
or use of one more unit of something.
Total Utility The total amount of
satisfaction obtained from consumption
of a good or service.
 Measuring Utility
Amount consumed (8 Total Utility Marginal Utility
ounce glasses)
0 0 -
1 40 40
2 60 20
3 70 10
4 75 5
5 73 2

Utility Derived From Drinking Water After

Running Four Miles
Utility Maximizing Conditions
Consumer Equilibrium the condition
in which an individual consumers
budget is exhausted and the last dollar
spent on each good yields the same
marginal utility; therefore; utility is
maximized.
Total and Marginal Utilities From
Pizza and Movies
Consu Total Margin Margin Viewed Total Margin Margin
med Utility al al per Utility al al
per Utility Utility week Utility Utility
week per per
Dollar Dollar
if P = if P =
$8 $4
0 0 - - 0 0 - -
1 56 56 7 1 40 40 10
2 88 32 4 2 68 28 7
3 112 24 3 3 88 20 5
4 130 18 2 4 100 12 3
5 142 12 1 5 108 8 2
Pizza Movie Rentals
6 150 8 1 6 114 6 1 1/2
 Total and Marginal Utilities From Pizza
and Movies After the Price of Pizza
Consu Total
Decreases
Margin Margin
from $8
Viewed
to $6
Total Margin Margin
med Utility al al per Utility al al
per Utility Utility week Utility Utility
week per per
Dollar Dollar
if P = if P =
$6 $4
0 0 - - 0 0 - -
1 56 56 9 1/3 1 40 40 10
2 88 32 5 1/3 2 68 28 7
3 112 24 4 3 88 20 5
4 130 18 3 4 100 12 3
5 142 12 2 5 108 8 2
6 150 Pizza 8 1 1/3 6 Movie
114 Rentals
6 1 1/2
 The Budget Constraint
budget constraint The limits imposed on household
choices by income, wealth, and product prices.

choice set or opportunity set The set of options that is

defined and limited by a budget constraint.
The Budget Line and
Indifference Curve
 The Budget Line and
Indifference Curve
Budget line is a graphical representation of the
amount of goods a consumer can afford.
Indifference curve is a line illustrating a
consumers responsiveness or indifference based
on a combination of two products (X and Y). It also
shows an infinite combination of X and Y, which
gives the same level of satisfaction
 Income Effect
Price changes affect households in two ways. First, if we assume that households
confine their choices to products that improve their well-being, then a decline in the
price of any product, ceteris paribus, will make the household unequivocally better
off.

In other words, if a household continues to buy the same amount of every good and
service after the price decrease, it will have income left over. That extra income may
be spent on the product whose price has declined, hereafter called good X, or on
other products.

The change in consumption of X due to this improvement in well-being is called the

income effect of a price change.
 Substitution Effect
When the price of a product falls, that product also becomes
relatively cheaper. That is, it becomes more attractive relative to
potential substitutes. A fall in the price of product X might cause a
household to shift its purchasing pattern away from substitutes
toward X. This shift is called the substitution effect of a price
change.

Everything works in the opposite direction when a price rises,

ceteris paribus. When the price of a product rises, that item
becomes more expensive relative to potential substitutes and the
household is likely to substitute other goods for it.
 Determinants of Household
Demand
The price of the product
The income available to the household
The households amount of accumulated wealth
The prices of other products available to the household
The households tastes and preferences
The households expectations about future income,
wealth, and prices
Consumer and
producer surplus
 Willingness to Pay (WTP)
A buyers willingness to pay for a good is the maximum
amount the buyer will pay for that good.
WTP measures how much the buyer values the good.

Example:
4 buyers WTP
for an iPod
WTP and the Demand Curve
Q: If price of iPod is $200, who will buy an iPod, and what is quantity
demanded?
A: Anthony & Flea will
buy an iPod, Chad &
John will not.
Hence, Qd = 2
when P = $200.
WTP and the Demand Curve
Derive the demand
schedule:

Price Who buys Quantity Demanded

300 and up Nobody 0
251 300 Flea, Anthony 1
176 250 Anthony, Flea 2
126 175 Chad, Anthony, Flea 3
0 125 John, Flea, Chad, 4
Anthony
WTP and the Demand Curve
P
P Qd

$301 & up 0

251 300 1

176 250 2

126 175 3

0 125 4
Q
About the Staircase Shape
P This D curve looks like a
staircase
with 4Ifsteps
there were
one per buyer.
a huge # of
buyers, as in a competitive
market,
there would be a huge #

of very tiny steps,

and it would look
more like a
smooth curve.

Q
WTP and the Demand Curve
P At any Q,
Fleas
the height of
WTP
Anthonys the D curve is
WTP the WTP of the
marginal
Chads WTP
Johns buyer, the
WTP buyer who
would leave the
market if P were
any higher.

Q
 Consumer Surplus (CS)
Consumer surplus is the amount a buyer is willing
to pay minus the amount the buyer actually pays:
CS = WTP P

name WTP Suppose P = $260.

Fleas CS = $300 260 =
Anthony $250
$40.
Chad 175
The others get no CS
Flea 300 because they do not buy an
iPod at this price.
John 125
Total CS = $40.
CS and the Demand Curve
P
Fleas P = $260
WTP Fleas CS =
$300 260 =
$40
Total CS = $40

Q
CS and the Demand Curve
P
Fleas Instead, suppose
WTP
Anthonys P = $220
WTP
Fleas CS =
$300 220 =
$80
Anthonys CS =
$250 220 =
$30
Total CS = $110
Q
CS and the Demand Curve
P
The lesson:
Total CS equals
the area under
the demand
curve above the
price, from 0 to
Q.

Q
CS with Lots of Buyers & a Smooth D
Curve
Price P The demand for
per pair shoes
$
At Q =
5(thousand), the
marginal buyer is
willing to pay $50
for pair of shoes. 1000s of
pairs of
Suppose P = $30.
shoes
Then his D
consumer surplus Q
= $20.
 Cost and the Supply Curve
Cost is the value of everything a seller must
give up to produce a good (i.e., opportunity
cost).
Includes cost of all resources used to produce
good, including value of the sellers time.
Example: Costs of 3 sellers in the lawn-cutting
business.
name cost A seller will produce and
sell the good/service only if
Jack $10 the
Janet 20 price exceeds his or her
cost.
Chrissy 35
Hence, cost is a measure
 Cost and the Supply Curve

P Qs
Derive the supply
schedule from the cost $0 9 0
data: 10 19 1

20 34 2
name cost 35 &
3
Jack $10 up

Janet 20
Chrissy 35
Cost and the Supply Curve
P
P Qs

$0 9 0

10 19 1

20 34 2

35 & up 3

Q
Cost and the Supply Curve
P
At each Q,
Chrissy the height of
s the S curve
cost is the cost of
Janets the marginal
cost seller,
the seller who
Jacks cost would leave
the market if
Q the price were
any lower.
 Producer Surplus
P PS = P cost
Producer surplus
(PS): the amount a
seller
is paid for a good
minus the sellers
cost

Q
Producer Surplus and the S
Curve
P PS = P cost

Chrissy Suppose P =
s $25.
cost Jacks PS = $15
Janets
Janets PS = $5
cost
Chrissys PS =
Jacks cost $0
Total Total
Total PS
PS PS =the
equals
equals $20
the
Q area
area above
above the
the
supply
supply curve
curve under
under
the
the price,
price, from
from 00 to
to
Q.
PS with Lots of Sellers & a Smooth S
Curve
Price P The supply of shoes
per pair

Suppose P = $40. S
At Q =
15(thousand), the
marginal sellers
cost is $30, 1000s of
pairs of
and her producer shoes
surplus is $10.
Q
 CS, PS, and Total Surplus
CS = (value to buyers) (amount paid by buyers)
= buyers gains from participating in the
market
PS = (amount received by sellers) (cost to
sellers)
= sellers gains from participating in the
market
Total surplus = CS + PS
= total gains from trade in a market
= (value to buyers) (cost to sellers)