ch 6 consumer choice

total utility

• generally, consumers are trying to maximize ? (or satisfaction) given their budget constraint

utility

1 unit of satisfaction

marginal utility

the additional satisfaction that we get from consuming an additional unit

budget constraint line

• shows the various combinations of 2 goods that are affordable given consumer income

CANNOT

• it is important to note that you ? (can/cannot) make comparisons btw the utils of individuals

• if 1 person gets 20 utils from coffee and another gets 10 utils, doesn’t mean that the first person gets more enjoyment from the coffee than the other or that they enjoy the coffee 2x as much

• utils are subjective to the individual

marginal utility

• the additional utility provided by one additional unit of consumption

• also subject to diminishing marginal utility, which holds that the additional utility decreases with each unit added

• the first tshirt jose picks is his favorite and it gives him an addition of 22 utils, but the fourth tshirt only yields 18 addt’l utils

marginal utility per dollar

marginal utility/price

rule for maximizing utility

• if you always choose the item with the greatest marginal utility per dollar spent

• when your budget is exhausted, the utility maximizing choice should occur where the marginal utility per dollar spent is the same for both goods

• ex., jose gets 22 units of utility from the first T-shirt and 11 units from the sixth movie

  • if the t-shirt costs 2x as much as the movie, then the utility per dollar is the same

inferior good

• occurs when ppl trim back on a good as income rises, bc they can now afford the more expensive choices that they prefer

how changes in prices affect consumer choices

• typical response to higher prices is that a person chooses to consume less of the product with the higher price

• 2 reasons (can simultaneously occur)

  • substitution effect

    • price changes, consumers have an incentive to consume less of higher priced good and more of the good w a relatively lower price

  • income effect

    • encourages a utility-maximizer to buy more of both goods if utility rises or less of both goods if utility falls (if they are both normal goods)

    • decrease qty of goods, purchase 2 movie tickets instead of 3

susbtitution effect

• occurs when a price changes and consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price

income effect

• the motivation encourages a utility-maximizer to buy more of both goods if utility rises or less of both goods if utility falls (if they are both normal goods)

• decrease qty of goods, purchase 2 movie tickets instead of 3

• think of this like a buying power effect

  • not a change in actual income, but a situation where the price of a good changes, and thus the quantities of goods that can be purchased with a fixed amt of income change

behavioral economics

• integrate psychology insights into economics to enrich understanding of decision-making

• e.g., argue that traditional economic models omit factor of people’s state of mind affecting decision making

loss aversion

• tend to focus more on the loss than the gain

• $1 loss pains us 2.25 times more than a $1 gain

indifference curve

• shows combos of goods that provide an equal level of utility or satisfaction

• have a roughly similar shape in 2 ways

  • downward sloping from L to R

    • steeper on L and flatter on R

    • means less trade off of one good to get more of the other, while holding utility constant

  • convex with respect to the origin

    • involves diminishing marginal utility (as person consumes more, the marginal utility from ea additional unit is less)

greater

• higher indifference curves represent a ? level of utility than lower ones

• UI: “low level of utility”

• UM: “medium level of utility”

• UH: “high level of utility”

  • all choices on indifference curve UH are preferred to all choices on indifference curve UM, which are preferred to all choices on UI

utility maximizing with indifference curves

ppl seek highest level of utility, meaning they wish to be on the highest possible indifference curve

shift to the R

• a rise in income causes the budget constraint to shift ?

utility maximizing with indifference curves/responses to price changes

• a higher price for a good will cause the budget constraint to shift to the L, so that it is tangent to a lower indifference curve representing a reduced level of utility

• conversely, a lower price for a good will cause the opportunity set to shift to the R, so that it is tangent to a higher indifference curve representing an increased level of utility

• exactly how much a change in price will lead to the qty demanded of ea good depends on personal preferences

change in price

• two interlinked motivations after a ?

  • substitution effect

    • when good becomes more expensive, ppl seek out substitutes

  • income effect

    • change in price of a good alters the effective buying power of one’s income

    • if the price of a good that you have been buying falls, then in effect your buying power has risen (can purchase more goods)

    • conversely, if the price of a good that you have been buying rises, then the buying power of a given amount of income is diminished

    • (don’t confuse with change in actual income- referring to more of a buying power effect)

indifference curves with labor-leisure and itnertemporal choices

• Indifference curves show combinations of two goods that give the same satisfaction (utility).

• Apply to choices like labor vs. leisure and present vs. future consumption.

---

Labor-Leisure Choice:

• Each curve shows combinations of leisure time and income with the same utility.

• Wage increase shifts the budget line, allowing a higher indifference curve.

  • Substitution effect (A → C): Leisure is more expensive, so Petunia works more (less leisure, more income).

  • Income effect (C → B): She can afford more of both, including some increase in leisure.

• Overall: Income rises; leisure may rise or fall depending on the strength of each effect.

Intertemporal Choice (Present vs. Future Consumption):

• Curves show tradeoffs between spending now vs. saving for future.

• Lower return on savings makes future consumption more expensive.

  • Substitution effect (A → C): More present, less future consumption.

  • Income effect (C → B): Reduced buying power leads to less of both.

• Overall: Present consumption increases if substitution effect is stronger.

intertemporal choice

• Curves show tradeoffs between spending now vs. saving for future.

• Lower return on savings makes future consumption more expensive.

  • Substitution effect (A → C): More present, less future consumption.

  • Income effect (C → B): Reduced buying power leads to less of both.

• Overall: Present consumption increases if substitution effect is stronger.

labor-leisure choice

• Each curve shows combinations of leisure time and income with the same utility.

• Wage increase shifts the budget line, allowing a higher indifference curve.

  • Substitution effect (A → C): Leisure is more expensive, so Petunia works more (less leisure, more income).

  • Income effect (C → B): She can afford more of both, including some increase in leisure.

• Overall: Income rises; leisure may rise or fall depending on the strength of each effect.

This is unlikely to be true. In general, demand elasticity increases as prices drop and quantities increase, so we would expect the second 10% decrease in price to be met with a larger than 8% increase in quantity.

If a 10% decrease in the price of one product that you buy causes an 8% increase in quantity demanded of that product, will another 10% decrease in the price cause another 8% increase (no more and no less) in quantity demanded?

is maximizing utility.

When Marietta chooses to only purchase a combination of goods that lie within her budget line, she:

Option A

is decreasing utility.

Option B

is maximizing utility.

Option C

must reduce the quantity.

Option D

likely has negative savings.

To integrate the insights of psychology into economics to enrich our understanding of decision-making.

What is the goal of behavioral economics?

Option A

To shift economic theory from a mathematical base to more of a psychological study.

Option B

To eliminate the consumers’ state of mind from consideration in economic analysis.

Option C

To integrate the insights of psychology into economics to enrich our understanding of decision-making.

Option D

To study consumer behavior over time rather than behavior in the moment and integrate these insights in economic analysis.

income effect; higher price

The term _____________ describes a situation where a ________________ causes a reduction in the buying power of income, even though actual income has not changed.

Option A

income effect; higher price

Option B

intertemporal budget; lower price

Option C

substitution effect; lower price

Option D

intertemporal budget; higher price

The tendency to focus more on the loss than the gain.

What is loss aversion?

Option A

The tendency of an individual to invest all of their resources to avoid losing.

Option B

The ability of humans to exercise complete self control in high stakes situations to avoid losing.

Option C

The temptation company’s face to invest in questionable techniques to avoid losing money.

Option D

The tendency to focus more on the loss than the gain.

The change in total utility / the change in quantity

Marginal utility is defined as the increment to total utility that results from the consumption of one more unit of some good or service. The equation for marginal utility is:

Option A

The change in quantity / the change in total utility

Option B

The change in total utility / the change in quantity

Option C

The change in total utility / the change in total revenue

Option D

Total revenue / quantity demanded

The price of designer jeans has increased, so the buying power of your income has been reduced. You purchase 2 new pairs of new jeans instead of 3 that year.

Which of the following best describes the income effect?

Option A

The price of designer jeans has increased, so you have less of an incentive to purchase new jeans. You purchase 3 pairs of chinos instead that year.

Option B

The gap between the rich and everyone else has gotten bigger.

Option C

The bank increases interest rates on savings accounts from .04% to 5%, so you start placing more of your monthly income in that savings account.

Option D

The price of designer jeans has increased, so the buying power of your income has been reduced. You purchase 2 new pairs of new jeans instead of 3 that year.

The degree to which concerts and overnight getaways are normal goods or inferior goods.

Kimberly has $1,000 per year to spend between $50 concert tickets and $200 per night getaways. Her utility maximizing combination is 8 concerts and 3 overnight getaways. 

She recently received a promotion on her job and now she can spend up to $2000 per year on these two items. Her new utility maximizing combination will depend in part on what?

Option A

The degree to which concerts and overnight getaways are normal goods or inferior goods.

Option B

The fact that concerts and getaways are fungible goods.

Option C

The substitution effect.

Option D

The income effect.

(The marginal utility associated with good 1 / the price of good 1) = (the marginal utility associated with good 2 / the price of good 2)

You were presented with a utility maximizing rule which states: If you always choose the item with the greatest marginal utility per dollar spent, when your budget is exhausted, the utility maximizing choice should occur where the marginal utility per dollar spent is the same for both goods. 

 That rule is expressed as follows:

Option A

(The marginal utility associated with good 1 / the price of good 1) = (the marginal utility associated with good 2 / the price of good 2)

Option B

The marginal utility per dollar of good 1 > the marginal utility per dollar of good 2.

Option C

(The marginal utility associated with good 1 / the price of good 2) = (the marginal utility associated with good 2 / the price of good 1)

Option D

% change in price / % change in quantity

In general, greater consumption of a good brings higher total utility. However, the additional utility received from each unit of greater consumption tends to decline in a pattern of diminishing marginal utility

Briefly discuss how greater consumption of a good affects utility.

Mental accounting is the notion of putting dollars in different mental categories where they take different values.

Explain the idea of mental accounting.

Option A

Mental accounting is the way people keep track of their mental assets and liabilities.

Option B

Mental accounting refers to the way we emotionally account for ups and downs of our lives.

Option C

Mental accounting is the notion of putting dollars in different mental categories where they take different values.

Option D

Mental accounting refers to the interest rate we use when we calculate the present value of future mental asse

2400

Jimmy saves part of his income to entertain himself once a year. He spends some of these savings on vacation and buying new clothes.

He spent $200 on his new clothes, his marginal utility from new clothes purchases is 300 utilis and his marginal utility from the vacation he went on is 3600 utilis. This means that his vacation must cost:

Option A

$4500

Option B

1600

Option C

3000

Option D

2400

8

Jed's weekly budget for lunch is $24. He eats only pizza and burgers. Each pizza costs $6 and each burger costs $3. Jed knows that 2 pizzas and 4 burgers will give him a utility of 8. At his utility-maximizing point, Jed's utility is:

Option A

6

Option B

4

Option C

8

Option D

10

utility

In microeconomic terms, the ability of a good or a service to satisfy wants is called:

Option A

profit potential

Option B

opportunity cost

Option C

utility

Option D

utility maximization

diminishing marginal utility

The term ___________________ is used to describe the common pattern whereby each marginal unit of a consumed good provides less of an addition to utility than the previous unit.

Option A

diminishing marginal utility

Option B

decreasing marginal utility

Option C

marginal utility pattern

Option D

marginal income utility

8

Rick eats only french fries and burgers at his office cafeteria. His weekly lunch budget is $24. Each burger costs $6 and each order of fries costs $3. When deciding how much of each good to buy, Rick knows that 2 burgers and 4 orders of French fries will give him a utility of 8. At his utility-maximizing point, Rick's utility is:

Option A

48

Option B

40

Option C

24

Option D

8

his tax on alcohol only impacts supply and demand trends within the liquor industry.

Say that a tax on alcohol leads to a higher price at the liquor store. Which of the following is NOT likely to occur?

Option A

Consumers spend less on other food items to compensate for this expense.

Option B

his tax on alcohol only impacts supply and demand trends within the liquor industry.

Option C

Alcoholic beverage consumption is likely to decrease.

Option D

The higher price of alcohol causes the budget constraint to pivot left.

3 movies; 3 gym workout sessions

Bob budgets $18 a week for entertainment. He splits his time between going to the movies and going to the gym. Each movie costs $3 and each session at the gym also costs $3. The total utility from each of these activities is shown in the table below. Bob’s utility maximizing point is:

Option A

4 movies; 2 gym workout sessions

Option B

1 movie; 5 gym workout sessions

Option C

3 movies; 3 gym workout sessions

Option D

4 movies; 0 gym workout sessions

3 salads, 6 vegetarian burgers

For lunch, Maria eats only salads or vegetarian burgers. Her weekly food budget is $36. Each salad costs $6 and each vegetarian burger costs $3. When deciding how much of each good to buy, Maria knows that 2 salads and 4 vegetarian burgers will give her a utility of 8. Maria’s utility-maximizing point is:

Option A

2 salads, 8 vegetarian burgers

Option B

3 salads, 6 vegetarian burgers

Option C

6 salads, 1 vegetarian burger

Option D

4 salads, 6 vegetarian burgers

demand curve

Examine the following diagram. With this information, what kind of curve could you derive?

Marginal Cost Curve

Option B

Supply Curve

Option C

Marginal Revenue Curve

Option D

Demand Curve

elective surgery due to its lower marginal return rate.

The government wants to make medicare benefits available to more people, but to achieve this goal, it needs to make cuts in the existing medicare budget. The two areas where they are considering cuts are non-essential elective surgery and 6-12 month mental health care programs. Applying the concept of diminishing marginal utility, the budget cuts should be made for spending on:

Option A

both programs, which have the same marginal return rate.

Option B

elective surgery due to its lower marginal return rate.

Option C

neither can be compared by measuring marginal utility.

Option D

mental health therapy due to its higher marginal return rate.

Use utils as a measure of utility, assigning a specific number to T-shirts and movies, and then add those together.

The goal of the consumer is to maximize the total utility or satisfaction derived from their purchase choices, given the unique budget constraint. To calculate total utility of a given combination of T-shirts and movies, one would use the following approach:

Option A

For a given combination of T-shirts and movies, survey a group of individuals to determine an average for utils to be assigned to the number of T-shirts and movies.

Option B

Use utils as a measure of utility, assigning a specific number to T-shirts and movies, and then add those together.

Option C

For a given combination of T-shirts and movies, assign a number of utils to that combination.

Option D

For a given combination of T-shirts and movies, use Google to identify the number of utils associated with the number of T-shirts and movies and then sum them.

the marginal utility per dollar is the same for both goods

Which of the following is considered to be a tell-tale signal that the point with the highest total utility has been found?

Option A

the demand curves are flatter reducing quantity

Option B

the marginal utility per dollar is the same for both goods

Option C

the quantities demanded change so total utility rises

Option D

the marginal utility per dollar is controlled by trade-offs

substitution effect

Which of the following occurs simultaneously with an income effect?

Option A

substitution effect

Option B

preferences effect

Option C

Giffen good effect

Option D

backward-bending supply curve

market demand to shift to the left.

A decrease in consumer preference for a product, other things being equal, will cause:

Option A

market demand to shift to the left.

Option B

market demand to shift to the right.

Option C

quantity demanded is not a price function.

Option D

a decrease in supply. 

$50

In May and June, Tammy spent all her clothing budget on bathing suits and beach bags. Each bathing suit cost $75. At Tammy’s optimal choice, her marginal utility from the last bathing suit purchased is 300 and her marginal utility from the last beach bag purchased is 200. This means that each handbag must cost

Option A

$150

Option B

$100

Option C

$25

Option D

$50

substitution effect

The ________________ arises when a price changes because consumers have an incentive to consume less of the good with a relatively higher price and more of the good with a relatively lower price.

Option A

preferences effect

Option B

income effect

Option C

substitution effect

Option D

backward-bending supply curve