ECON 200 Chapter 16: Consumer Choice

Click on the first point on the total utility curve where a rational consumer will stop eating brownies.

*5 Brownies=TOP OF CURVE: HIGHEST POINT ON TOTAL UTILITY CURVE (TUC)* (At this point the marginal utility turns negative, which means the consumer loses utils with each additional brownie consumed.) (*Too much of a good thing can be bad. People will stop consuming even their favorite products if marginal utility becomes negative.)

Ian gets 20 utils of satisfaction from eating a pear that costs $0.40. Calculate the corresponding marginal utility per dollar spent.

*50 util/$* (Once Ian understands how much utility $1.00 can buy him, he can begin to make better purchasing decisions.) 20/0.40=50

Suppose you have $19 to spend. Pepsi costs $1 per can, and pizza costs $2 per slice. Given the marginal utilities shown, what combination of pizza and Pepsi will maximize your satisfaction? Click the number of Pepsis and the number of pizza slices.

*9=Pepsis & 5=Pizza Slices* (9=Pepsis: $9 spent on Pepsi leaves $10 for pizza. 5=Pizza Slices: $10 spent on pizza leaves $9 for soda.)

If no one can live without groceries, then why do they cost less than big-screen TVs that no one really needs?

*Although the demand is higher for groceries than for TV's, supply is much greater for groceries.* (Price is a function of both supply and demand. The supply and demand curves intersect at a lower price for groceries than for TVs.)

Arsenios says he gets 70 utils per slice from eating pepperoni pizza versus 50 utils from eating cheese pizza. Stavros says he gets 60 utils from eating the same pepperoni pizza. What can we conclude?

*Arsenios prefers pepperoni pizza to cheese pizza.* (Since Arsenios assigned pepperoni pizza 20 more utils than cheese pizza, we can conclude that he gets more satisfaction from pepperoni pizza.)

Suppose that you have $10 to spend on Pepsi and pizza. Pepsi costs $1 per can, and pizza costs $1 per slice. Given the marginal utilities shown, which Pepsi-and-pizza combination(s) will maximize satisfaction? There may be more than one correct answer.

*CORRECT ANSWERS:* -5 Pepsis, 5 pizza slices (This will get you to a total of 95 utils.) -6 Pepsis, 4 pizza slices (This will get you to a total of 95 utils.) *INCORRECT ANSWERS:* -3 Pepsis, 7 pizza slices (The last couple of pizza slices are not adding to your total utility.) -4 Pepsis, 6 pizza slices (The last pizza slice is not adding to your total utility.) -7 Pepsis, 3 pizza slices (The last Pepsi is only worth 3 utils. What is the opportunity cost in utils of pizza?) (*Switching between the two optimal combinations would involve losing 4 utils' worth of one good but gaining 4 utils' worth of the other, a net change of zero.)

What are examples of the substitution effect and/or real-income effect?

*CORRECT ANSWERS:* -After subscription prices in the cable TV market fall, customers also purchase higher-speed Internet service. (This is an example of the real-income effect.) -Julie usually buys generic cereal because it is cheaper. One day she notices one of the brand-name products falls in price, so she decides to buy it. (This is an example of the substitution effect.) -Movie ticket prices plummet to $1, so you cancel your Netflix subscription in favor of attending movies at the theater. In addition, the cheap tickets leave you with extra money for concessions. (This is an example of both the substitution and real-income effects.) *INCORRECT ANSWERS:* -Kyle notices the cost of premium peanut butter has fallen. He considers this and then purchases less bread. (Kyle would probably purchase more bread, not less—either to go with the more-affordable peanut butter or because the savings on peanut butter gave him more money to spend generally. Buying less bread would make sense only if peanut butter and bread were substitutable, which they are not.)

Jeff has a budget of $2,000/month. He has many purchases to make each month. Which of the following describes how he will make purchasing decisions and achieve consumer equilibrium?

*CORRECT ANSWERS:* -He will buy goods and services that provide the best marginal utility per dollar spent possible. (In order to achieve his consumer equilibrium, Jeff will only make purchases that provide the best marginal utility per dollar spent.) -The ratio of marginal utility per dollar spent will be the same for each purchase. (This illustrates the concept of consumer equilibrium. Since Jeff has many purchases to make each month, he will need to make sure he gets the best marginal utility per dollar spent on each purchase. He will try to gain the same utility from each purchase to make the most of his budget.) *INCORRECT ANSWERS:* -Jeff will not need to take into account the marginal utility per dollar, only marginal utility per good purchased. (Each dollar Jeff spends should be used to buy as much utility as possible. This is commonly called "getting the biggest bang for the buck.") -The ratio of marginal utility per dollar spent for each purchase will be very different. (To achieve consumer equilibrium, the ratio of marginal utility per dollar spent for each purchase must be as similar as possible.) (*Jeff has more than two products to buy each month, which means he will have to try to achieve his consumer equilibrium to maximize his purchasing power.)

Match the activity to the level of marginal utility you might expect to see.

*DIMINISHING MARGINAL UTILITY* -sitting in a hot tub another 5 minutes, after having been in for an hour already (Hot tubs are enjoyable, but if you sit in one for too long you will get too hot and want to leave.) -the final stretch of a half-hour treadmill session (By the end of a workout session, most people are tired and want to stop.) *INCREASING MARGINAL UTILITY* -the first few minutes of playing a new game you just learned (Since most people are not good at a game the first time they play it, it is likely they will increase their enjoyment as they play and get better at it.) -the first couple of minutes of a shower as the water is warming up (A shower will likely not be enjoyable until the water has reached a comfortable temperature. In this scenario, marginal utility increases as the water temperature rises.) (*Although some activities have an increasing marginal utility for a short amount of time, eventually every activity's utility begins to diminish.)

Marginal utility never increases with quantity.

*False* (For example, marginal utility will increase when you play sports, as your body warms up. However, after playing for a while, marginal utility will begin to decrease as you get tired.)

When a price changes, it will always trigger both the substitution effect and the real-income effect.

*False* (If the price changes by only a small amount, it may not be enough to trigger the real-income effect. If a price changes and a consumer saves 3 cents, for example, that is unlikely to make a significant difference to the consumer's purchasing power.)

Products that are essential for life, such as water or groceries, yield more marginal utility than rare products, such as diamonds or luxury vehicles.

*False* (In many places, essential goods are plentiful and in high demand. Therefore, the total utility they yield is high. In contrast, most luxury items are rare and expensive. The cost of obtaining a diamond or luxury vehicle means that a consumer must get a great deal of marginal utility from the purchase to justify the expense.)

Lowering the price of a product is a simple way to increase the product's marginal utility for buyers.

*False* (Marginal utility is not the same as marginal utility per dollar.)

Match each good to the part of the graph that best depicts the corresponding consumer surplus.

*GAME CONSOLES:* -small patterned area (The demand for game consoles is much smaller than the demand for vegetables, but the price is higher because game consoles exist in far lower quantities than vegetables.) *VEGETABLES:* -large blue area (Consumers gain more consumer surplus from vegetables because they are consumed in large quantities.) (*This is a parallel to the diamond-water paradox. Game consoles are not necessary for survival and they have a lower demand than vegetables, but consumers are likely to buy them when the price is right because they have high marginal utility.)

For each example, identify whether the substitution effect or the real-income effect determines the change in consumption.

*SUBSTITUTION EFFECT* -Julie notices that a brand-name pasta product has dropped in price by $0.25, so she decides to buy it instead of the generic product she usually buys. (Julie substituted the higher-quality pasta for her usual purchase.) *REAL-INCOME EFFECT* -Juanita buys ordinary wheat bread most of the time but occasionally splurges on fancy bread, which is more expensive. When the ordinary bread goes up in price, Juanita stops splurging on the fancy bread. (The price increase on the everyday staple has reduced Juanita's purchasing power and forced her to give up the occasional treat of the fancy bread.) -Gas prices in David's town fell drastically. This allowed him to buy not only more gas and do more driving each week, but also allowed him to buy more of other goods. (David has more purchasing power through the money he saved from the lower-priced gas.)

Drag the labels to the appropriate part of the graph to illustrate the marginal utility of using a product.

*TOP=Highest Marginal Utility* (The first time consumers use a product satisfaction is generally the highest.) *MIDDLE=Positive-but diminishing-marginal utility* (Satisfaction declines with each additional use.) *BOTTOM=Beyond this point the consumer will likely stop using the product.* (Once the marginal utility becomes negative, the consumer will have no reason to continue using the product.) (*Marginal utility decreases at a different rate for each person.)

During lunch, Tori receives 15 utils from a single slice of meatloaf, 10 utils from a second slice, and 5 utils from a third. Meatloaf usually costs $1.50 a slice. To stay within her personal budget, Tori buys two slices for lunch every day. She skips dessert, which would cost $1 and would give Tori another 3 utils. What can she be expected to do if the price of meatloaf drops to $1.00 a slice? Assume that the rest of her lunch remains unchanged.

*Tori will buy three slices of meatloaf and continue to skip dessert.* (The marginal utility per dollar is 15 util/$ on the first slice and 10 util/$ on the second one. Between dessert and the third slice, 5 util/$ for meatloaf is a better choice than 3 util/$ for dessert.) (*This is a good example of the real-income effect.)

How do rational consumers choose what to spend their money on?

1. Consumers always choose the highest valued alternative. 2. One good can be substituted for another 3. More of a good thing isn't always better

Diamond-Water Paradox

A paradox stating that (1) the things with the greatest value in use frequently have little or no value in exchange and (2) the things with the greatest value in exchange frequently have little or no value in use.

Fill in the blanks to complete the passage about total utility and marginal utility.

A util is a unit of *SATISFACTION* that quantifies a person's preferences for some goods when compared with others. *TOTAL UTILITY* represents the sum amount of satisfaction a person receives as a result of consuming a product or service. *MARGINAL UTILITY* is the additional satisfaction of consuming one more unit of that product or service. (Utility theory makes it possible to do quantitative analysis, such as optimization calculations, on people's subjective preferences.)

Jennifer has $30 to spend. She can get 15 utils out of a lunch that costs $18 and 10 utils from watching a movie that costs $12. Alternatively, she can have a steak dinner that costs $30 and is worth 20 utils to her. Fill in the blanks to describe Jennifer's choice situation.

Jennifer can maximize her satisfaction by choosing the *LUNCH AND MOVIE*. That way she is getting *0.83* utils per dollar, which is better than the *0.67* utils per dollar she would be getting out of the *STEAK DINNER*. (15 utils + 10 utils = 25 utils $18 + $12 = $30 25/30 = 0.83 20 utils/$30 = 0.67 (0.6666 round up to the nearest hundred )) (*Maximizing utility means spending the fewest dollars per util, or equivalently, getting as many utils per dollar as possible.)

What is marginal utility?

The additional satisfaction obtained by a consumer from consuming 1 more unit of a good.

What is diminishing marginal utility?

The more we have of something, the less marginal utility each unit of that good brings us. (Think of your favorite food. Why don't you just consume that all of the time?)

What is utility?

Utility is the satisfaction or well-being that a consumer receives from consuming a good or service. -utilities vary from individual to individual -economists measure this in utils -goal of the consumer is to maximize their utility