The Logic of Consumer Choice and Demand

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Chapter 6 The Logic of Consumer Choice and
Demand PURPOSE to provide a small taste of
economic theory. Develop a conceptual model to
explain the Law of Demand. SKIP the Appendix
and Income and Substitution Effects (pp. 147-150)
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• ASSUMPTIONS OF DEMAND THEORY
• Consumers have utility functions (or preferences)
  which show the levels of satisfaction achieved
  (per period) from consumption of all goods.
• Goods have prices.
• Consumers have given incomes.
• Consumers seek to maximize their utility subject
  to their budget constraint. Rational behavior.
• Principle of declining marginal utility.

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Definition Utility - A measure of the level of
satisfaction achieved by an individual as a
result of consumption of goods. An abstract
concept representing the consumer's preferences.
Taken as given. "Measured" in utils. Definition
Marginal Utility - the amount by which total
utility changes when consumption increases (or
decreases) by one unit. Principle of
Diminishing Marginal Utility - Marginal Utility
of a good declines as consumption of that good
increases, ceteris paribus.
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Example Number Total Marginal of
Beers Utility Utility 0 50 --
1 90
40 2
140
50 3 180
40 4
210
30 5 230
20 6
240
10 7 230
-10 8
130
-100
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Figure 6.1a
Total Utility and Marginal Utility
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Figure 6.1b
Total Utility and Marginal Utility
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Consumers Problem (2 goods) Maximize UU
(Beer,Pretzels) Subject to pBB ppP
I Consumer maximizes level of satisfaction
subject to his budget constraint (determined by
prices and income). Solution MUB/pB
MUp/pp In English Consumers allocate their
incomes among the goods they purchase so that the
marginal utility per dollar spent on each product
is the same. Note The solution takes into
account 1) Preferences 2) Income 3) Prices
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EXAMPLE M C Pizza
(p 2) (p
10) Marginal
Marginal Units Utility
MU/P Utility MU/P
1 50 25
80 8 2
8 4 50
5 3 4
2 40 4
4 2 1
20 2 5
0 0 10
1 6 -2
-1 0
0 7 -10 -5
-40 -4 Solutions
M C Pizza I 2
1
0 I 34 2
3 I 40
3 4
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• Some Common Questions/Misconceptions
• Do not equate marginal utilities (to do so
  ignores prices)
• Do not always consume product with greater MU
  (again, ignores prices)
• Some goods are not consumed (even some with great
  MU). For these
• MUM/pM lt MUc1/pc1 MUc2/pc2 MUc3/pc3
• Consumption of partial units is possible.

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Consumer Equilibrium and the Law of
Demand Equation representing consumer
equilibrium holds for all goods
purchased MU1/p1 MU2/p2
MUn/pn Question What must happen to the
quantity of good i purchased if the price of that
good increases, ceteris paribus? Answer Quantity
purchased must fall if price increases. Initiall
y, after pi increases, MUi/pi lt
MUj/pj Then, consuming less i causes MUi
?. Work through for a price decrease.