Chapter 6

Consumer Choice Theory

Lecture Slides
Economics for Today’s World
Irvin B. Tucker
1
© 2011 South-Western, a part of Cengage Learning
 What does this
chapter cover?
• It expands the
understanding of demand
by investigating why
people buy goods and
services
2
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 What does utility mean?

• The satisfaction, or
pleasure, that people
receive from consuming
a good or service
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 What is total utility?
• The amount of satisfaction
received from all the units
of a good or service
consumed

4
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 What is marginal utility?
•The change in total
utility from one
additional unit of a
good or service
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 Why does a consumer
buy one bundle of
goods, rather than
another?
• Consumers make one
choice over another
depending on their
marginal utility
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© 2011 South-Western, a part of Cengage Learning
 What is the law of
diminishing
marginal utility?
• The principle that the
extra satisfaction (MU) of
a good or service
declines as additional
units are consumed
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© 2011 South-Western, a part of Cengage Learning
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

total utility
30
0 0 20
10
1 10 0

2 18 0 1 2 3 4
quantity
5 6 7 8

3 24
4 28
5 30
6 30
7 28
Microeconomics, Chapter 7
8
© 2002 McGraw-Hill Ryerson Ltd.
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

total utility
30
0 0 20
10
1 10 0

2 18 0 1 2 3 4
quantity
5 6 7 8

3 24
4 28
5 30
6 30
7 28
Microeconomics, Chapter 7
9
© 2002 McGraw-Hill Ryerson Ltd.
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

total utility
30
0 0 20
10
1 10 0

2 18 0 1 2 3 4
quantity
5 6 7 8

3 24
4 28
5 30
6 30
7 28
Microeconomics, Chapter 7
10
© 2002 McGraw-Hill Ryerson Ltd.
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

total utility
30
0 0 20

1 10 10 10
0

2 18 0 1 2 3 4
quantity
5 6 7 8

3 24 Marginal Utility
4 28 marginal utilitiy
15

5 30 10
5
0
6 30 -5 0 1 2 3 4 5 6 7 8
quantity
7 28
Microeconomics, Chapter 7
11
© 2002 McGraw-Hill Ryerson Ltd.
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

total utility
30
0 0 20

1 10 10 10
0

2 18 8 0 1 2 3 4 5 6 7 8
quantity

3 24
Marginal Utility
4 28 marginal utilitiy

15
5 30 10
5
6 30 0
-5 0 1 2 3 4 5 6 7 8

7 28 quantity

Microeconomics, Chapter 7
12
© 2002 McGraw-Hill Ryerson Ltd.
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

total utility
30
0 0 20

1 10 10 10
0

2 18 8 0 1 2 3 4 5 6 7 8
quantity

3 24 6
Marginal Utility
4
4 28
2
marginal utilitiy
15

5 30 10
5
0 0
6 30 -5 0 1 2 3 4 5 6 7 8
-2 quantity
7 28
Microeconomics, Chapter 7
13
© 2002 McGraw-Hill Ryerson Ltd.
 Total and Marginal Utility
Figure 7-1
Tacos Total Marginal
consumed Utility Utility Total Utility

per meal DTU 40

Observe

total utility
30
0 0 20
Diminishing
1 10 10 10

8
0
Marginal
2 18 0 1 2

Utility
3 4
quantity
5 6 7 8

3 24 6
4 Marginal Utility
4 28
2
marginal utilitiy
15

5 30 10

0 5

6 30 0

-2 -5 0 1 2 3 4 5 6 7 8

7 28 quantity

Microeconomics, Chapter 7
14
© 2002 McGraw-Hill Ryerson Ltd.
 Theory of Consumer Choice
A Typical Consumer.…
• Exhibits rational behavior
• Knows clear-cut preferences
• Is subject to a budget constraint
• Responds to price changes
 When is total
utility maximized?
• If the marginal utility
per last dollar spent on
each good is equal and
the entire budget is
spent, total utility is
maximized. 16
© 2011 South-Western, a part of Cengage Learning
 Table 7-1

Product A p=$1 Product B p=$2

unit of marginal
utility
MU/p MU MU/p
product
1st 10 10 24 12
2nd 8 8 20 10
3rd 7 7 18 9
4th 6 6 16 8
5th 5 5 12 6
6th 4 4 6 3
7th 3 3 4 2

Microeconomics, Chapter 7
17
© 2002 McGraw-Hill Ryerson Ltd.
 Decision-Making Process
MU/p, MU/p, Product Product
Spending
Product A Product B A B

1st  10 1st  12 $2 1
2nd 8 2nd 10 $3 1 1
3 rd rd
7 3 
What
9
will the
4 th consumer
6 4 th  8 buy
$2 first? 1

5th 5 5th 6 $3 1 1
6 th 4 6 th
And
3
next?
$10 2 4
7th 3 7th 2

Microeconomics, Chapter 7
18
© 2002 McGraw-Hill Ryerson Ltd.
 Utility Maximization
• at each step, spend where MU/$ is highest
• in general, if MU/$ is unequal, spending
should be allocated
– away from the good where MU/$ is low
– toward the good where MU/$ is high
 Algebraic Restatement of the
Utility Maximization Rule

MU of product A MU of product B

Price of A
= Price of B

8 units 16 units
= $2
$1
 Consumer Equilibrium
Price of Product B = $1

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© 2011 South-Western, a part of Cengage Learning
 What happens to the
number of Product B
bought when the price
drops?
• To restore maximum
total utility, the
consumer spends
more on Product B
22
© 2011 South-Western, a part of Cengage Learning
 What does this
discussion of utility
reveal?
• The law of demand, that
is, as the price of a good
declines, consumers will
buy more units of the
good, and vice versa
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 Utility Maximization &
the Demand Curve
Deriving the Demand Curve
• what if the price of Product B falls to $1?
 Table 7-1

Product A p=$1 Product B p=$1

unit of marginal
utility
MU/p MU MU/p
product
1st 10 10 24 24
2nd 8 8 20 20
3rd 7 7 18 18
4th 6 6 16 16
5th 5 5 12 12
6th 4 4 6 6
7th 3 3 4 4

Microeconomics, Chapter 7
25
© 2002 McGraw-Hill Ryerson Ltd.
 Decision-making Process
MU/p, MU/p, Product
Spending Product A
B
Product A Product B
$1 1
1st  10 1st  24
$1 1
2nd 8 2nd 20 $1 1
3rd  7 3rd  18 $1 1
4th  6 4th  16 $1 1
5th 5 5th  12 $1 1
6th 4 6th  6 $1 1
7th 3 7th 4 $1 1
$1 1 1
$10 4 6
Microeconomics, Chapter 7
26
© 2002 McGraw-Hill Ryerson Ltd.
 Utility Maximization &
the Demand Curve
• when priceProduct B=$2
the quantity demanded is 4
• when priceProduct B=$1
the quantity demanded is 6
Utility Maximization & the Demand Curve

Figure 7-2

price D
Product B
$2
price quantity demanded

$1 6
$1

$2 4

4 6

quantity demanded

Microeconomics, Chapter 7
28
© 2002 McGraw-Hill Ryerson Ltd.
 Utility Maximization &
the Demand Curve
• Substitution Effect
when the price of Product B falls, there is a
substitution of now cheaper B
• Income Effect
increase in real income increases
consumption of both A & B
What are two alternative
explanations of
demand?
•Income effect
•Substitution effect
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 What is the
income effect?
• The change in quantity
demanded of a good or
service caused by a
change in real income
(purchasing power)
31
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 What does the
income effect show?
• As prices decline, your
real income increases,
increasing your buying
power, so you buy more
units, ceteris paribus
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 Quantity demanded of
good X increases

Real purchasing
power increases

Price of good X falls

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 What is the
substitution effect?
• The change in quantity
demanded of a good or
service caused by the
change in its price
relative to substitutes
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 What does the substitution
effect show?
• Suppose the price of a
Pepsi falls and the price of a
Coke remains unchanged;
you will buy more Pepsi,
because relatively, it is less
expensive than Coke
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 Quantity demanded
of good X increases

Consumers switch from good Y

to good X

Price of competing
good Y rises
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 What do the
substitution and
income effects prove?
• The law of demand, that
is, as the price of a good
declines, consumers will
buy more units of the
good, and vice versa
37
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 Even though water
provides a greater
utility than
diamonds, why are
diamonds more
expensive?

• Water is plentiful in
most of the world, so its
marginal utility is low
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 Exhibit 2(a) Marginal Utility of Diamonds

S
Marginal Utility per Carat
(utils)

MUd

MU
0 Quantity of Diamonds
13
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part of Cengage Learning
(carats per year)
 Exhibit 2 Marginal Utility of Water

S
Marginal Utility per
gallon (utils)

MUw
MU
0 Quantity of Water
14
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part of Cengage Learning
(gallons per year)
END

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