Consumer Choice and Demand

  • Chapter Objectives:

    • Understand constraints of budget lines on consumer choices
    • Analyze changes in budget lines due to price or income variations
    • Distinguish between total utility and marginal utility
    • Explain the law of diminishing marginal utility
    • Discuss the utility maximization rule and consumer optimization
    • Compare marginal utility per dollar across goods
    • Explore reasons for irrational decision-making in predictable ways
    • Identify five psychological factors affecting economic decisions

  • Budget Line:

    • Represents combinations of two goods purchasable within a fixed budget and prices.
    • Changes in prices or income shift the budget line, affecting consumption choices.
    • Example: Increased income shifts line outward, while decreased income shifts it inward.

  • Utility:

    • Total Utility: Overall satisfaction from consuming a quantity of a good.
    • Marginal Utility: Additional satisfaction from consuming one more unit; tends to decrease with consumption (diminishing returns).

  • Utility Maximization Rule:

    • Consumers maximize satisfaction by equalizing marginal utility per dollar across all goods.

  • Demand Curve Relationships:

    • Price changes of goods influence optimal combinations purchased; reflected in movements along demand curves.

  • Behavioral Economics:

    • Examines the psychological factors influencing economic decisions:
    1. Sunk Cost Fallacy
    2. Framing Bias
    3. Overconfidence
    4. Overvaluing Present vs. Future
    5. Altruism

  • Key Concepts:

    • Budget Line
    • Marginal Utility Analysis
    • Total Utility
    • Law of Diminishing Marginal Utility
    • Utility-Maximizing Rule
    • Behavioral Economics

  • Indifference Curves:

    • Illustrate combinations of goods providing equal satisfaction.
    • Curves further from the origin indicate greater satisfaction.

  • Consumer Choices:

    • Optimal choice occurs at highest indifference curve tangent to budget line, maximizing satisfaction given budget constraints.