Consumer Choice
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C H A P T E R 6 Prepared by: Fernando and Yvonn Quijano © 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed. Consumer Choice
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Consumer Choice. How do you choose?. Consumer Choice. Consumer choice theory is based on the notion that consumers do the best they can, given the limitations dictated by their incomes and consumer prices. Consumer Constraints: The Budget Line. - PowerPoint PPT Presentation
Transcript of Consumer Choice
C H A P T E R
6
Prepared by: Fernando and Yvonn Quijano
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
Consumer Choice
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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How do you choose?
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Consumer Choice
• Consumer choice theory is based on the notion that consumers do the best they can, given the limitations dictated by their incomes and consumer prices.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Consumer Constraints:The Budget Line
• Budget line: The line connecting all the combinations of two goods that exhaust a consumer’s budget.
• Budget set: A set of points that includes all the combinations of goods that a consumer can afford, given the consumer’s income and the prices of the goods.
• Price ratio: The ratio of the price of one good to the price of a second good; the market trade-off.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Consumer Preferences: Indifference Curves
• Indifference curve: A curve showing the different combinations of two goods that generate the same level of utility or satisfaction.
• Utility: The satisfaction experienced from consuming a product.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Consumer Preferences: Indifference Curves
• Marginal rate of substitution (MRS): The rate at which a consumer is willing to trade or substitute one good for another.
• The slope of the indifference curve is the marginal rate of substitution between two goods.
• Superior combinations generate higher utility (point h).
• Inferior combinations generate lower utility (point r).
• Equivalent combinations generate the same utility (points on the curve).
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Consumer Preferences: Indifference Curves
• An indifference map shows a set of indifference curves, each with a different level of utility.
• Utility increases as we move northeasterly to higher indifference curves (from C1 to C2 to C4 and so on).
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Maximizing Utility
• The consumer maximizes utility at tangency of an indifference curve and a budget line (point e).• Point z does not exhaust the
entire budget.• Point b does not lie on the
highest indifference curve that can be reached.
• Point w is desirable but not affordable.
• Point e generates maximum utility.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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The Utility-Maximizing Rule:MRS = Price Ratio
• Utility-maximizing rule: Pick the affordable combination that makes the marginal rate of substitution equal to the price ratio.
book of pricemovie of price
MRS
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Drawing theDemand Curve
• At a price of $3 per movie, utility is maximized with 4 movies and 18 books.
• At a price of $2 per movie, utility is maximized with 7 movies and 16 books.
• The individual demand for movies shows the quantity of movies demanded at each price level.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Applications of theConsumer Choice Model
Music Piracy and Online Music Stores• When music is sold as
bundles on CDs, the consumer has budget points rather than an entire budget line. Each CD carries 15 songs and has a price of $15, so the consumer buys songs in multiples of 15.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Applications of theConsumer Choice Model
Music Piracy and Online Music Stores• If songs are sold
individually, the consumer has a full budget line and can legally reach his or her ideal combination of 6 songs and 48 arcade games (point i).
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Applications of theConsumer Choice Model
Inflation, the Real-Nominal Principle, and Consumer Choice• Inflation does not affect the consumer’s decision
because it does not affect the budget set. This is an application of the real-nominal principle.
The REAL-NOMINAL PrincipleWhat matters to people is the real value of money or income—its purchasing power—not the “face” value of money or income.
© 2006 Prentice Hall Business Publishing Economics: principles and tools Arthur O’Sullivan, Steven M. Sheffrin—4 th ed.
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Applications of theConsumer Choice Model
The Equimarginal Rule• If the marginal benefit per dollar spent on
one thing exceeds the marginal benefit per dollar spent on a second, do more of the first and less of the second. To get the best possible combination of the two things, pick the mix that equalizes the marginal benefit per dollar spent.
