# Chapter 10. Consumer Choice and Behavioral Economics

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1 Chapter 10. Consumer Choice and Behavioral Economics Instructor: JINKOOK LEE Department of Economics / Texas A&M University ECON Principles of Microeconomics

2 Utility Utility: the satisfaction people receive from consuming goods and services. the goal of a consumer is to maximize utility given available income. Utility is a difficult concept to measure. there is no way of knowing exactly how much satisfaction someone receives from consuming a product. Nevertheless, if we assume that utility is something directly measurable, the economic model of consumer behavior is easier to understand.

3 Marginal Utility Suppose that you have just arrived at a Super Bowl party, where the hosts are serving pizza that you want to eat. Marginal utility (MU): The change in total utility a person receives from consuming one additional unit of a good. (Total utility and Marginal utility)

4 Marginal Utility Law of diminishing marginal utility: consumers experience diminishing additional satisfaction (MU) as they consume more of a good during a given period of time. Total utility

5 Marginal Utility Law of diminishing marginal utility: consumers experience diminishing additional satisfaction (MU) as they consume more of a good during a given period of time. Marginal utility

6 The Rule of Equal Marginal Utility per Dollar Spent Now, suppose you attend a Super Bowl party at a restaurant, where Coke as well as pizza are served. you have \$10 to spend on Coke and pizza. Price pizza = \$2, Price Coke = \$1 Budget constraint: the limited amount of income available to consumers to spend on goods and services. Since budget is limited, every consumer has to make trade-offs between consuming pizza and Coke. Then, how many slices of pizza and how may cups of Coke do you buy in order to maximize your utility?

7 The Rule of Equal Marginal Utility per Dollar Spent how many slices of pizza and how may cups of Coke do you buy in order to maximize your utility? (Total Utility and Marginal Utility from Eating Pizza and Drinking Coke)

8 The Rule of Equal Marginal Utility per Dollar Spent how many slices of pizza and how may cups of Coke do you buy in order to maximize your utility? (Converting Marginal Utility to Marginal Utility/\$)

9 The Rule of Equal Marginal Utility per Dollar Spent The rule of equal marginal utility per dollar spent To maximize the total utility (given limited income), you should buy pizza and Coke up to the point where the last slice of pizza and the last cup of Coke give you equal increases in utility per dollar. In short, marginal utility per dollar spent must be the same for both goods. MU pizza P pizza = MU Coke P Coke Then, is this the only condition for maximizing utility?

10 Budget Constraint There are three combinations that satisfy the rule of equal marginal utility per dollar spent. (1 pizza, 3 Coke) would cost just \$5 (leaving you with \$5 to spend) (4 pizza, 5 Coke) would cost \$13 (exceeding your budget) (3 pizza, 4 Coke) total spending is equal to the amount available to be spent.

11 The Two Conditions for Maximizing Utility We can summarize the two conditions for maximizing utility. 1 marginal utility per dollar spent must be the same for both goods MU pizza P pizza = MU Coke P Coke 2 Spending on pizza + Spending on Coke = Income P pizza Q pizza + P Coke Q Coke = Income

12 The Income Effect and Substitution Effect of a Price Change Suppose you are back at the restaurant for the Super Bowl party, but this time the price of pizza decrease to \$1.5. you have still \$10 to spend on Coke and pizza. Price pizza = \$1.5, Price Coke = \$1

13 The Income Effect and Substitution Effect of a Price Change The fall in the price of pizza to \$1.5 has two effects on the quantity of pizza (Q pizza ) Income effect: The change in the quantity demanded of a good that results from the effect of a change in the good s price on consumers purchasing power. Q pizza increase if pizza is a normal good. Q pizza decrease if pizza is a inferior good. Substitution effect: The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes. fall in the price of pizza relative to the price of Coke causes you to eat more pizza and drink less Coke.

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