Chapter 05: Demand, Utility & Rational Spending Principles | Microeconomics | Trường Đại học Quốc tế, Đại học Quốc gia Thành phố Hồ Chí Minh

Chapter 5 Demand
© 2022 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw Hill. Learning Objectives
1. Relate the law of demand to the Cost-Benefit Principle.
2. Discuss how individual wants are translated into demand using utility maximization.
3. Explain the reasoning behind the rational spending rule and apply it to
consumer decision making to show how the rule is related to
substitution and income effects.
4. Discuss the relationship between the individual demand curve and the market demand curve.
5. Define and calculate consumer surplus. 2 © 2022 McGraw Hill. Free Ice Cream Ð Or Is It?
" The cost of a good extends beyond its monetary cost 3 Waiting in line 3 Purchasing a permit 3 Participating in a lottery
" "Free" ice cream attracts so many consumers that the time spent
waiting in line acts as the price of the good
" Demand curves relate the quantity demanded to ALL costs, not just monetary costs 3 © 2022 McGraw Hill. Law of Demand Law of Demand:
People do less of what they want to do as the cost of doing it rises 4 © 2022 McGraw Hill. Law of Demand
" Cost-Benefit Principle at work
3 Do something if the marginal benefits are at least as great as the marginal costs
" An increase in the market price approaches our reservation price
3 If market price exceeds the reservation price, buy no more
3 Costs include ALL costs Ð money, time, reputation
" Consider implicit and explicit costs 5 © 2022 McGraw Hill. Origins of Demand " Reservation price
3 Individual tastes and preferences differ § Biological needs ¥ Cultural influences § Peer behavior ¥ Individual differences § Perceived quality ¥ Expected benefits 3 Tastes may change over time
" New goods get incorporated into priorities 6 © 2022 McGraw Hill. Needs Versus Wants
" Some goods are required for subsistence are needs
3 Required to maintain our health: food, shelter, and clothing
" Beyond subsistence, behavior is driven by wants " Wants depend on price 3 Water in California
" Regulations or price mechanism
3 Regulations are cumbersome and expensive
3 Price changes are fast and effective 7 © 2022 McGraw Hill. California Water Shortages
" Problem: California has a large population and relatively
low annual rainfall, so some argue that water shortages are inevitable " Analysis
3 New Mexico has less rainfall per person and fewer shortages
3 California's water price is low
3 Low price discourages careful use
" Rice and almonds are grown because water is cheap
" Water-intensive home landscaping 8 © 2022 McGraw Hill. Wants and Demand " Unlimited wants
3 More things, better quality things
3 Services, including entertainment and travel " Limited resources 3 Money, income, and wealth 3 Time and energy " Prioritize wants
3 Allocate resources accordingly
3 Demand those things for which you are willing and able to pay 9 © 2022 McGraw Hill. Wants and Utility
" Utility: the satisfaction people derive from consumption 3 Well-being, happiness 3 Measured indirectly " Subjective " Observable
3 Cannot be compared between people
" Individual goal is to maximize utility
3 Allocate resources accordingly 10 © 2022 McGraw Hill. Sarah's Utility from Ice Cream Cones / 0 1 2 3 4 5 6 Hour Total Utility 0 50 90 120 140 150 140 150 140 120 hour 9 tils/ 0 U 5 0 1 2 3 4 5 6 Cones/hour 11 © 2022 McGraw Hill.
Sarah's Marginal Utility from Ice Cream Cones / 0 1 2 3 4 5 6 Hour Total Utility 0 50 90 120 140 150 140 Marginal Utility 50 40 30 20 10 -10
" Marginal utility: the additional utility
gained from consuming an additional unit of a good Change in utility
Marginal utility = Change in consumption 12 © 2022 McGraw Hill. Diminishing Marginal Utility
Law of Diminishing Marginal Utility:
Tendency for the additional utility gained
from consuming an additional unit of a good
to diminish as consumption increases beyond some point 13 © 2022 McGraw Hill. Diminishing Marginal Utility
" Marginal utility can increase at low levels of consumption
3 First unit stimulates your desire for more
" Eventually marginal utility declines 3 Continue consuming " Apply Cost-Benefit Principle
3 Consume an additional unit as long as the marginal
utility (benefit) is greater than the marginal cost 14 © 2022 McGraw Hill. Spending on Two Goods " Assume a fixed budget " Decide how much of each tility Marginal utility good to buy increases as " Law of Diminishing Marginal Returns applies quantity arginal U - As you buy more of a single M decreases good, its marginal utility decreases - When you buy less of that good, its marginal utility tility Marginal utility increases decreases as - Remember, marginal utility is not satisfaction overall but quantity satisfaction from consuming arginal U increases one more M 15 © 2022 McGraw Hill. SarahÕs Ice Cream " $400 budget
" Buy 200 pints of vanilla and " Chocolate is $2 per pint 100 pints of chocolate " Vanilla is $1 per pint " Marginal utility is 12 for vanilla, 16 for chocolate Vanilla Chocolate Ice Cream Ice Cream 16 (utils/ pint) 12 (utils/ pint) U U M M 200 100 Pints/yr Pints/yr 16 © 2022 McGraw Hill. SarahÕs Next Step " Increase vanilla by 100
" Marginal utility of vanilla is " Reduce chocolate by 50 8 " Marginal utility of chocolate is 24 Vanilla Chocolate Ice Cream Ice Cream 24 16 (utils/ pint) 12 (utils/ pint) U U M 8 M 200 300 50 100 Pints/yr Pints/yr 17 © 2022 McGraw Hill. SarahÕs Equilibrium " Optimal combination: " Marginal utility / price is highest total utility the same for all goods " 250 pints vanilla; 75 " Marginal utility of vanilla pints chocolate 10, chocolate 20 Vanilla Chocolate Ice Cream Ice Cream 20 (utils/ pint) 10 (utils/ pint) U U M M 250 75 Pints/yr Pints/yr 18 © 2022 McGraw Hill. SarahÕs Choices Scenario Marginal Price Quantity MU / $ 1 Utility Vanilla $1 200 12 12 Chocolate $2 100 16 8 Scenario Marginal Price Quantity MU / $ 2 Utility Vanilla $1 300 8 8 Chocolate $2 50 24 12 Scenario Marginal Price Quantity MU / $ 3 Utility Vanilla $1 250 10 10 Chocolate $2 75 20 10 19 © 2022 McGraw Hill. Rational Spending Rule The Rational Spending Rule:
Spending should be allocated across goods
so that the marginal utility per dollar is the same for each good 20 © 2022 McGraw Hill.