The Logic of Individual Choice: The Foundation of Supply and Demand ppt

© 2003 McGraw-Hill Ryerson Limited         Chapter 8 Chapter 8 © 2003 McGraw-Hill Ryerson Limited. 8 - 2     ◆ Economists have an answer to the question of why people behave as they do — self interest. ● Economists' analysis of individual choice does not deny individual dierences. © 2003 McGraw-Hill Ryerson Limited. 8 - 3     ◆ A good beginning in understanding individual choice is to focus on the rational part of people's behavior. © 2003 McGraw-Hill Ryerson Limited. 8 - 4     ◆ Using the simple concept of self- interest, two things determine what people do: ● The pleasure people get from doing or consuming something. ● The price of doing or consuming that something. © 2003 McGraw-Hill Ryerson Limited. 8 - 5     ◆ Price is the market's tool to bring quantity supplied equal to the quantity demanded. ◆ Changes in price provide incentives for people to change what they are doing. © 2003 McGraw-Hill Ryerson Limited. 8 - 6   ◆ Economists start with a proposition that individuals try to get as much pleasure as possible out of life. ◆ The goods and services we consume provide value (satisfaction) to us. © 2003 McGraw-Hill Ryerson Limited. 8 - 7   ◆ Individuals want to maximize the amount of satisfaction they receive through consuming goods and services. © 2003 McGraw-Hill Ryerson Limited. 8 - 8   ◆ Economists use the concept of utility— the pleasure or satisfaction that one gets from consuming a good or service. ◆ A util is a unit created by economists to “measure” utility. © 2003 McGraw-Hill Ryerson Limited. 8 - 9   ◆ Utility serves as the basis of economists' analysis of individual choice. ◆ It is personal and individual. ◆ Utility cannot be compared across individuals. © 2003 McGraw-Hill Ryerson Limited. 8 - 10   ◆ Total utility refers to the total satisfaction one gets from consuming a product. [...]... leads to the law of demand q When the price of a good goes up, the marginal utility per dollar from that good goes down and we demand less of it © 2003 McGraw-Hill Ryerson Limited 8 - 36 Rational Choice and the Law of Demand Initially MUx/Px = MUy/Py x When the price of good y goes up, then MUx/Px > MUy/Py x Our condition for maximizing utility is no longer satisfied x So when the price of a good... that the opportunity cost of not consuming good x is greater than the opportunity cost of not consuming good y So we consume x © 2003 McGraw-Hill Ryerson Limited 8 - 34 Opportunity Cost x When all the marginal utilities per dollar spent are equal, the opportunity cost of all the alternatives are equal © 2003 McGraw-Hill Ryerson Limited 8 - 35 Rational Choice and the Laws of Demand x The principle of. .. you do not enjoy consuming more of a good x It only states that as you consume more of the good, you enjoy additional units less than you enjoyed the initial units © 2003 McGraw-Hill Ryerson Limited 8 - 17 Rational Choice and Marginal Utility The analysis of rational choice begins with the premise that rational individuals want as much satisfaction as they can get from their available income x Rational... additional unit of good y © 2003 McGraw-Hill Ryerson Limited 8 - 23 Maximizing Utility By substituting the marginal utilities and prices of goods into these formulas, you can always decide which good it makes more sense to consume x Consume the one with the highest marginal utility per dollar x © 2003 McGraw-Hill Ryerson Limited 8 - 24 Maximizing Utility and Equilibrium x When the ratios of the marginal... McGraw-Hill Ryerson Limited 8 - 30 Rational Choice and Marginal Utility x When MUx MUy MUz = = you are maximizing utility Px Py Pz © 2003 McGraw-Hill Ryerson Limited 8 - 31 Rational Choice and Marginal Utility When this principle is met, the consumer is in equilibrium x The cost per additional unit of utility is equal for all goods and the consumer is as well off as it is possible to be x © 2003 McGraw-Hill... Rational Choice and Marginal Utility x The rule does not say that the rational consumer should consume a good until its marginal utility reaches zero x Consumers do not have enough money to reach this point, as they face an income constraint © 2003 McGraw-Hill Ryerson Limited 8 - 33 Opportunity Cost x Opportunity cost is the benefit forgone of the next-best alternative q x x It is essentially the marginal... Ryerson Limited 8 - 28 Rational Choice and Marginal Utility The same principle applies if more than two goods are consumed: x If MUx/Px > MUz/Pz, consume more of good x x If MUy/Py > MUz/Pz, consume more of good y x © 2003 McGraw-Hill Ryerson Limited 8 - 29 Rational Choice and Marginal Utility x The general utility-maximizing rule is that you are maximizing utility when the marginal utilities per dollar... 20 10 0 Total utility 1 2 3 4 5 6 7 8 9 Slices of pizza per hour 16 14 12 10 8 6 4 2 0 -2 Marginal utility 1 2 3 4 5 6 7 8 9 Slices of pizza per hour © 2003 McGraw-Hill Ryerson Limited 8 - 15 Diminishing Marginal Utility x The principle of diminishing marginal utility states that, at some point, the marginal utility received from each additional unit of a good begins to decrease with each additional...8 - 11 Marginal Utility x Marginal utility refers to the satisfaction one gets from the consumption of one additional unit of a product above and beyond what on has consumed up to that point © 2003 McGraw-Hill Ryerson Limited 8 - 12 Total Utility and Marginal Utility x As additional units are consumed, marginal utility decreases while total utility... income x Rational means that people prefer more to less and will make choices that give them as much satisfaction as possible x © 2003 McGraw-Hill Ryerson Limited 8 - 18 Rational Choices In making choices, essentially what you are doing is buying units of utility x Any choice (for the same amount of money) that does not give you as many units of utility as possible is an irrational choice x © 2003 . 9   ◆ Utility serves as the basis of economists' analysis of individual choice. ◆ It is personal and individual. ◆ Utility cannot be compared across individuals. © 2003 McGraw-Hill. 2     ◆ Economists have an answer to the question of why people behave as they do — self interest. ● Economists' analysis of individual choice does not deny individual dierences. © 2003 McGraw-Hill. 17 ' '   ◆ The analysis of rational choice begins with the premise that rational individuals want as much satisfaction as they can get from their available income. ◆ Rational