Chapter 20 – Consumer Choice
There have been shifts in air travel away from
facilities located in larger metro areas.
San Francisco International Airport saw a
decline in air passenger traffic, while Oakland
International Airport had a gain.
At Cleveland Hopkins International Airport
passenger volume also fell, while Ohio’s
Akron-Canton Airport saw volume rise.
20-1
Learning Objectives
• Distinguish between total utility and
marginal utility
• Discuss why marginal utility at first rises
but ultimately tends to decline as a person
consumes more of a good or service
• Explain why an individual’s optimal choice
of how much to consume of each good
or service entails equalizing the marginal
utility per dollar spent across all goods
and services
20-2
Learning Objectives
• Describe the substitution effect of a price
change on the quantity demanded of a
good or service
• Understand how the real-income effect of a
price change affects the quantity demanded
a good or service
• Evaluate why the price of diamonds is
so much higher than the price of water
even though people cannot survive long
without water
20-3
Did You Know That...
• There has been a proliferation of choices at
U.S. grocery stores, which now stock an
average of 40,000 items?
• One way of deriving the law of demand
involves an analysis of the logic of consumer
choice in a world of limited resources?
• In this chapter we discuss what is called
utility analysis.
20-4
Utility Theory
• Utility
 The want-satisfying power of a good or service
• Utility Analysis
 The analysis of consumer decision making based
on utility maximization
• Util
 A representative unit by which utility is measured
20-5
Utility Theory
• Marginal Utility
 The change in total utility due to a
one-unit change in the quantity of
a good or service consumed
Change in total utility
Marginal utility =
Change in number of units consumed
20-6
Graphical Analysis
• We can appreciate total and marginal
utility by using graphical analysis.
20-7
Figure 20-1 Total and Marginal Utility
of Downloading and Listening to Digital
Music Albums, Panel (a)
20-8
Figure 20-1 Total and Marginal Utility
of Downloading and Listening to Digital
Music Albums, Panel (b)
20-9
Figure 20-1 Total and Marginal Utility
of Downloading and Listening to Digital
Music Albums, Panel (c)
20-10
Figure 20-1
Total and
Marginal Utility
of Downloading
and Listening
to Digital
Music Albums,
Panels (b) and (c)
Total utility is
maximized...
…where marginal
utility equals zero.
20-11
Graphical Analysis
• Observations
 Marginal utility falls as more is consumed.
 Marginal utility equals zero when total
utility is at its maximum.
20-12
Example: The High Cost of Certain
Sources of Negative Marginal Utility
• Conventional wisdom says that
it is impossible to put a price tag
on happiness.
• Economists usually attempt to attach
dollar values to economic goods.
• What is the amount of compensation
required for economic “bads?”
20-13
Diminishing Marginal Utility
• Diminishing Marginal Utility
 The principle that as more of any
good or service is consumed, its extra
benefit declines
 Increases in total utility from consumption
of a good or service become smaller
and smaller as more is consumed during a
given time period.
20-14
Example: Newspaper Vending Machines
versus Candy Vending Machines
• How many people take more than
one paper from the vending machine?
• Why not dispense candy the
same way?
• The answer is found in the concept of
diminishing marginal utility.
20-15
Optimizing Consumption Choices
• Consumer Optimum
 A choice of a set of goods and services
that maximizes the level of satisfaction for
each consumer, subject to limited income
20-16
Table 20-1 Total and Marginal Utility from
Consuming Music Album Downloads and
Sandwiches on an Income of $26
20-17
Table 20-1 Total and Marginal Utility from
Consuming Music Album Downloads and
Sandwiches on an Income of $26
20-18
Table 20-1 Total and Marginal Utility from
Consuming Music Album Downloads and
Sandwiches on an Income of $26
20-19
Optimizing Consumption Choices
• A consumer’s money income should
be allocated so that the last dollar
spent on each good purchased
yields the same amount of marginal
utility (when all income is spent),
because this rule yields the largest
possible total utility.
20-20
Optimizing Consumption
Choices
• A little math
 The rule of equal marginal utilities per
dollar spent
 A consumer
maximizes personal satisfaction
when allocating money income in such a way
that the last dollars spent on good A, good B,
good C, and so on, yield equal amounts
of marginal utility.
20-21
Optimizing Consumption
Choices
• A little math
 The rule of equal marginal utilities per
dollar spent
MU of good A
MU of good B
MU of good Z
=
= ... =
Price of good A
Price of good B
Price of good Z
20-22
How a Price Change Affects
Consumer Optimum
Recall from Table 20-1 Income = $26
Qd = 4
MUd
36.5
= 7.3
=
Pd
5
Qs = 2
MUs
22
=
Ps
3
= 7.3
20-23
How a Price Change Affects
Consumer Optimum
Assume Price of Music Falls to $4
Qd = 4
MUd
36.5
= 9.125
=
Pd
4
Qs = 2
MUs
22
=
Ps
3
= 7.3
20-24
How a Price Change Affects
Consumer Optimum
Assume Price of Music Falls to $4
Now
Result
MUd
MUs
>
Pd
Ps
Buy more downloads
and MUd falls
20-25
How a Price Change Affects
Consumer Optimum
• Consumption decisions are
summarized in the law of demand
 The amount purchased is inversely related
to price.
• A consumer’s response to a
price change
 At higher consumption rate, marginal
utility falls.
20-26
Figure 20-3 Digital Music Download
Prices and Marginal Utility
20-27
How a Price Change Affects
Consumer Optimum
• The Substitution Effect
 The tendency of people to substitute
cheaper commodities for more
expensive commodities
20-28
How a Price Change Affects
Consumer Optimum
• The Principle of Substitution
 Consumers and producers shift away
from goods and resources that become
priced relatively higher in favor of goods
and resources that are now priced
relatively lower.
20-29
How a Price Change Affects
Consumer Optimum
• Purchasing Power
 The value of money for buying goods
and services
20-30
How a Price Change Affects
Consumer Optimum
• Real-Income Effect
 The change in people’s purchasing power
that occurs when, other things being
constant, the price of one good that they
purchase changes
 When that price goes up (down),
real income, or purchasing power,
falls (increases).
20-31
The Demand Curve Revisited
• Question
 How is the demand curve derived?
• Answer
 By presuming income, tastes,
expectations, and the price of related
goods are not changing as the price of the
good changes
20-32
The Demand Curve
Revisited
• Marginal utility, total utility, and the
diamond-water paradox
 Water is essential to life but cheap.
 Diamonds are not essential to life
but expensive.
20-33
Figure 20-4
The Diamond-Water Paradox
20-34
Issues and Applications:
The Upside of Taking Off from
a Less Convenient Airport
• According to the principle of substitution,
people shift away from consuming items that
become priced relatively higher in favor of
items that are now priced relatively lower.
• In recent years, the principle of substitution
has applied to the services offered by several
major airports.
• Many consumers of air travel are choosing to
drive some distance before they depart to
their ultimate destinations by plane.
20-35
Issues and Applications:
The Upside of Taking Off from
a Less Convenient Airport
• Weighing relative marginal utilities
and prices
• Opting to avoid hassles that reduce
marginal utility
• Responding to price changes
20-36
Table 20-3 Selected Substitute
Airport Pairs in the United States
20-37
Summary Discussion
of Learning Objectives
• Total utility versus marginal utility
 Total utility is total satisfaction
from consumption.
 Marginal utility is the additional satisfaction
from consuming an additional unit.
• Law of diminishing marginal utility
 Marginal utility ultimately declines as a
person consumes more and more of a
good or service.
20-38
Summary Discussion
of Learning Objectives
• The consumer optimum
 Occurs when the marginal utility per
dollar spent on the last unit consumed
is equalized
• The substitution effect of a
price change
 A person will substitute among goods
by buying less of a good when its
price increases.
20-39
Summary Discussion
of Learning Objectives
• The real-income effect of a
price change
 A price change affects the purchasing
power of an individual’s available income.
• Why the price of diamonds exceeds
the price of water even though people
cannot long survive without water
 Marginal utility, not total utility, determines
how much people are willing to pay.
20-40