Electric Potential WS 2RoseHulman.doc

Consumer Choice and DemandChapter11I.Calculate and graph a budget line that shows the limits to a persons consumption possibilities.A.The Budget LineB.A Changes in the BudgetC.Changes in Prices1.A Fall in the Price of Water2.A Rise in the Price of WaterD.Prices and the Slope of the Budget Line2.Explain marginal utility theory and use it to derive a consumers demand curve.A.Utility1.Temperature: An AnalogyB.Total UtilityC.Marginal UtilityD.Maximizing Total Utility1.Allocate the Available Budget2.Equalize the Marginal Utility Per Dollar SpentE.Finding An Individual Demand CurveF.The Power of Marginal AnalysisG.Units of Utility3.Use marginal utility theory to explain the paradox of value: Why water is vital but cheap while diamonds are relatively useless but expensive.A.Consumer EfficiencyB.The Paradox of Value1.Consumer SurplusnWhats New in this Edition?Chapter 11 uses a see-saw analogy to give a more intuitive explanation of why equalizing the marginal utility per dollar maximizes total utility. The material that related elasticity to marginal utility is deleted.nWhere We AreIn this chapter, we uncover the consumers behavior that leads to a downward-sloping demand curve. The consumer maximizes utility by allocating his or her entire budget while equating the marginal utility per dollar spent across all goods. As a result, the demand curve reflects choices a consumer is willing to make that maximize his or her utility. The chapter concludes by investigating the paradox of value. nWhere Weve BeenThe first three sections of the book focused heavily on demand and supply. The demand and supply model was developed and then extended to discuss efficiency, externalities, public goods, common resources, and government policies such as price ceilings, price floors, and taxes.nWhere Were GoingAfter this chapter, the focus turns to exploring the supply curve in greater detail. Chapter 12 looks at a firms production choices and its total product function. After examining the firms production, we examine its costs and its cost curves in the short run and in the long run.IN THE CLASSROOMnClass Time NeededYou can complete this chapter in two to two and a half class sessions, depending the mathematical level of your class. An estimate of the time per checkpoint is:· 11.1 Consumption Possibilities25 to 35 minutes· 11.2 Marginal Utility Theory50 to 80 minutes· 11.3 Efficiency, Price, and Value15 to 20 minutesCHAPTER LECTUREn11.1Consumption PossibilitiesThe Budget Line· Households have limited budgets, which means they must choose between affordable combinations of goods and services. A budget line, illustrated in the figure, shows the limits to a households consumption choices. The household can buy any combination of sodas and movies that lies on or within the budget line.A Change in the Budget· When the persons budget changes, the budget line shifts and its slope does not change. If the budget increases, the budget line shifts outward; if the budget decreases, the budget line shifts inward.A Change in Prices· When the price of the good measured along the horizontal axis (movies) changes, the budget line rotates around the vertical intercept. If the price of the good falls, the budget line rotates outward and becomes steeper; if the price of the good rises, the budget line rotates inward and becomes steeper.· When the price of the good measured along the vertical axis (sodas) changes, the budget line rotates around the horizontal intercept. If the price of the good falls, the budget line rotates outward and becomes less steep; if the price of the good rises, the budget line rotates inward and becomes less steep.· A relative price is the price of one good divided by the price of another good. The magnitude of the slope of the budget line is the relative price of the good on the horizontal axis in terms of the good on the vertical axis, or in the diagram, the relative price of a movie in terms of sodas. A relative price is an opportunity cost, so the relative price of a movie in terms of sodas gives the opportunity cost of a movie in terms of sodas forgonen11.2Marginal Utility TheoryUtility· The benefit or satisfaction that a person gets from the consumption of a good or service is called utility. Quantity of moviesTotalutilityMarginal utility0 024124202441636012472· Total utility is the total benefit that a person gets from the consumption of goods and services. As more of a good or service is consumed, total utility increases. Marginal utility is the change in total utility that results from a one-unit increase in the quantity of a good consumed. Diminishing marginal utility is the principle that as more of a good or service is consumed, its marginal utility decreases.· The table to the right has the total utility and marginal utility from an individuals consumption of movies in a week.Maximizing Total UtilityA consumers choices influence the total level of his or her utility by because the choice determines the combination of goods that are consumed. Some combinations will generate more utility than others. The key assumption of marginal utility theory is that the household consumes the combination that maximizes its utility.· The utility-maximizing rule has two steps:· Allocate the entire available budget· Make the marginal utility per dollar equal for all goods. The marginal utility per dollar is the marginal utility from a good relative to the price paid for the good, which is the marginal utility from a good divided by its price.· This rule maximizes utility because anytime the marginal utility per dollar spent on one good exceeds that of another good, the consumer can increase his or her total utility by spending a dollar less on the good with the lower marginal utility per dollar spent and spending the dollar on the good with the higher marginal utility per dollar spent.Quantity of moviesMarginal utilityQuantityof booksMarginalutility1241202202103183 84 84 65 45 46 26 2· The table to the right has the marginal utility schedules that are computed from the total utility schedules in the table above. The price of a movie is $8, the price of a paper back book is $4, and the consumer has $24 to allocate between movies and books. To maximize utility, the individual buys 2 movies and 2 books because that combination of movies and books spends all the available income and sets the marginal utility per dollar spent of movies equal to that of books. (Both equal 2.50.).To show that maximizing total utility requires equalizing the marginal utility per dollar spent on each good, work with the case when they are not equal. Suppose the marginal utility per dollar spent on a movie is 20 and the marginal utility per dollar spent on a soda is 10. Ask “If you gained an additional dollar, what would you spend it on and how much would your total utility increase?” The students will spend it on movies and their total utility will rise by 20. Now ask “If you lost a dollar, what you cut back on and how much would your total utility decrease?” The students will cut back on sodas and their total utility will fall by 10. Now tell them that they can gain a dollar by cutting back a dollar on sodas. Ask them the net change in their total utility, which is +10. The point to make is that anytime the marginal utility per dollar spent on one good differs from that of another good, the students can rearrange their consumption by cutting back on the good with the low marginal utility per dollar spent and spending the dollar on the good with the high marginal utility per dollar spent and increase their total utility.Finding an Individual Demand Curve· If the price of a good falls and other things remain the same, the marginal utility per dollar spent on that good rises. As a result, the consumer increases his or her purchases of that good in order to maximize utility. (As more of the good is purchased, its marginal utility decreases; as less of other goods are purchased, their marginal utilities increase. Eventually the consumer reaches a new equilibrium at which the marginal utility per dollar spent on all the goods are equal.)· When the price of a good falls, the consumer substitutes the now lower priced good for the other good. So, when the price of a good falls, the consumer increases the quantity demanded, which is the law of demand.· When the price of a good rises, the consumer substitutes away from the now higher priced good for the other good. So, when the price of a good rises, the consumer decreases the quantity demanded, which is the law of demand.n11.3Efficiency, Price, and ValueConsumer Efficiency· The demand curve is a consumers marginal benefit curve. Because the demand curve is derived by maximizing utility, marginal benefit is the maximum price a consumer is willing to pay for an extra unit of a good or service when utility is maximized.Paradox of Value· The paradox of value is that water, which is essential to life, costs little, but diamonds, which are useless in comparison to water, are expensive.· The resolution to this paradox comes from distinguishing total utility and marginal utility. The total utility from water is much more than from diamonds. But we have so much water that its marginal utility is small. And we have so few diamonds that their marginal utility is high. When a household maximizes its utility, it makes the marginal utility per dollar spent equal for all goods. Because diamonds have a high marginal utility, they have a high price. Because water has a low marginal utility, it has a low price.· The consumer surplus from water exceeds the consumer surplus from diamonds.nLecture Launchers1.Use the paradox of value to start your lecture. Ask students how much they are willing to pay for a gallon of water. Of course, theyll answer a relatively low amount. Then ask them how much they would be willing to pay for a diamond. Most students will answer hundreds or thousands of dollars. Then ask them “Why?” Remind them that water is essential for life and that it makes no sense to be willing to spend so little for such a valuable item. Spark some more discussion by asking them their willingness to pay for water versus their willingness to pay for diamonds if they were lost in the desert. When you finish the days lecture, ask students if they can explain the paradox. Reassure them this topic is difficult to understand. In fact, so difficult that until the concepts of utility and marginal utility were discovered in the 1800s, the paradox could not be explained.2.A major component of consumer demand is preferences, which vary between consumers. A good starting place might be to have the students name some things they had bought recently and explain why they did so. Then find someone else who would not have made the same purchase, and explain why. Often we see that someone else has bought something we regard as silly or useless, and mentally question it thinking “isnt it strange what some people would rather have than money.” That the item was purchased at all is evidence that at least at the time of purchase, the good or service was more desirable than money3.Once you have introduced the idea of marginal utility, ask your students why a vending machine, which requires payment for each snack purchased, is used to sell snacks while a newspaper can be sold out of a box that allows anyone to take more than one paper. If students fail to respond using marginal utility analysis, prompt them by asking, “If snacks were sold using a newspaper style box, would some people take more than they paid for?” Then ask, “Why dont people take more than one paper?” See if the students can discover diminishing marginal utility on their own. If not, explain why different sales techniques are used: Because the marginal utility of a paper diminishes so rapidly, there is little concern that people take more than one. When you have formally taught diminishing marginal utility, tie your lecture back into this example.nLand Mines1.Students are introduced to another curve in this chapter, the budget line. Remind them that this line is not a demand curve nor a production possibilities frontier. Point out the differences: A demand curve is graphed in price/quantity space and shows how the quantity demanded of a product depends on its price; a budget line is graphed in good A/good B space and shows combinations that can be afforded; and although a PPF is also graphed in good A/good B space, it applies to a nation as whole and shows what can be produced. However, the budget line is similar to the PPF because both show limits.2.To help students remember how the budget line shifts when the prices of goods change, suggest they should assume they spend ALL of their income on either good. For example, suppose apples are on the x-axis, and oranges are on the y-axis. Ask students, “What happens if the price of apples increases?” Tell them to assume that they hate apples and regardless of the price of apples, they spend their entire budget on oranges. Because the price of oranges doesnt change, ask how the change in the price of apples impacts the number of oranges they can buy. Point out the y-intercept and stress the fact that this is the consumption point at which all their budget is spent on oranges. Make it clear that this point does not change when the price of apples rises. Then turn to the x-axis and tell students that they now buy only apples and no oranges. Discuss with them that the x-intercept shows the maximum number of apples they can buy when they spend all their budget on apples. While pointing out the x-intercept, ask students what happens to the number of apples they can buy when the price of apples rises. When they answer “fewer apples,” move your finger leftward along the x-axis and make a mark. Then draw the new budget line: the y-intercept does not change while the x-intercept rotates inward, making the budget line steeper. The point of this exercise is to focus on the intercepts and not the slope. For many students, this is an easier method of determining the change in the budget line. To complete the exercise, let the price of oranges fall and go through the same mechanics.3.Students often struggle with the concept of marginality. A brief and very sloppy use of Bethams utility calculus might solve the problem while getting the basic concept across. One sweater gives me 25 utils of bliss, while the second is worth only 23 utils, and so on, until a point come when one more sweater will provoke negative utility as not only have I run out of room in my closet but Ive just bee