Ragan: Economics

Fifteenth Canadian Edition

Chapter 6
Consumer Behaviour

Copyright © 2017 Pearson Canada Inc. 6-1

 Course Schedule
Unit Chapter / Topic
1 Chapter 1: Economic Issues and Concepts
Chapter 2: Economic Theories, Data and Graph
2 Chapter 3: Demand, Supply, and Price
3 Chapter 4: Elasticity
Chapter 5: Markets in Action
4 Chapter 6: Consumer Behavior
5 Chapter 7: Productions in the Short Run
Chapter 8: Productions in the Long Run
6 Chapter 9: Competitive Markets
Mid Exam (1.5 hours)
7 Chapter 10: Monopoly, Cartels, and Price Discrimination
Chapter 11: Imperfect Competition and Strategic Behavior
8 Chapter 12: Economic Efficiency and Public Policy

9 Chapter 13: How Factor Markets Work

10 Chapter 16: Market Failures and Government Intervention

11 Final Exam (2.5 hours)

Copyright © 2017 Pearson Canada Inc. 6-2

Chapter Outline/Learning Objectives
Section Learning Objectives
After studying this chapter, you will be able to
6.1 Marginal Utility and 1. describe the difference between marginal and
Consumer Choice total utility.
2. explain how utility-maximizing consumers
adjust their expenditure until the marginal
utility per dollar spent is equalized across
products.
6.2 Income and Substitution 3. understand how the slope of any demand
Effects of Price Changes curve is determined by the income and
substitution effects of price changes.
6.3 Consumer Surplus 4. see that consumer surplus is the “bargain” the
consumer gets by paying less for the product
than the maximum price he or she is willing to
pay.
5. explain the “paradox of value.”

Copyright © 2017 Pearson Canada Inc. 6-3

6.1 Marginal Utility and Consumer Choice (1
of 2)

Utility is the satisfaction that a consumer receives from

consuming some good or service.

Total utility is the consumer’s total satisfaction resulting

from the consumption of a given product.

Marginal utility is the additional satisfaction obtained from

consuming one additional unit of a product.

Copyright © 2017 Pearson Canada Inc. 6-4

6.1 Marginal Utility and Consumer Choice
(2 of 2)

Law of Diminishing Marginal Utility

Definition: The utility that any consumer derives from
successive units of a particular product consumed over some
period of time diminishes as total consumption of the product
increases (holding constant the consumption of all other
products).

Example: Think about your total utility from water. Initially, the
utility you receive is high. As you use more and more water,
your marginal utility from each additional glass decreases.

Copyright © 2017 Pearson Canada Inc. 6-5

 Utility Schedules & Graphs
Figure 6-1 Total and Marginal Utility
Bottles Total Marginal
Utility Utility
0 0
1 30 30
2 50 20
3 65 15
4 75 10
5 83 8
6 89 6
7 93 4
8 96 3
9 98 2
10 99 1

Copyright © 2017 Pearson Canada Inc. 6-6

 Utility Maximizing Choice

1. Total Utility Approach

2. Marginal Utility per Dollar Approach

Copyright © 2017 Pearson Canada Inc. 6-7

 Utility Maximizing Choice
1. Total Utility Approach
Consumers want to get the most utility possible from their limited
resources. They make the choice that maximizes utility. Let’s find
Lisa’s utility-maximizing choice. Suppose her total income is $40
and she wants 2
products, movies
& Soda, the price
of which is $8
& $ 4 respectively.

Source: Microeconomics, 11th Edition, 2014, Michael Parkin, Pearson Higher Education, USA
I Copyright © 2017 Pearson Canada Inc. 6-8
 Utility Maximizing Choice

Illustration of Table 8.2

Find the Just-Affordable Combinations: Table 8.2 shows the combinations of
movies and soda that Lisa can afford and that exhaust her $40 income.
Find the Total Utility for Each Just-Affordable Combination: Table 8.2 shows
the total utility that Lisa gets from the just-affordable quantities of movies and soda.
In row C of the table, Lisa sees 2 movies and buys 6 cases of soda. She gets 90
units of utility from movies and 225 units of utility from soda. Her total utility from
movies and soda is 315 units. This combination of movies and soda maximizes
Lisa’s total utility. That is, given the prices of movies and soda, Lisa’s best choice
when she has $40 to spend is to see 2 movies and buy 6 cases of soda.
Consumer Equilibrium: We’ve just described Lisa’s consumer equilibrium. A
consumer equilibrium is a situation in which a consumer has allocated all of his or
her available income in the way that maximizes his or her total utility, given the
prices of goods and services. Lisa’s consumer equilibrium is 2 movies and 6 cases
of soda.
Source: Microeconomics, 11th Edition, 2014, Michael Parkin, Pearson Higher Education, USA
I
Copyright © 2017 Pearson Canada Inc. 6-9
 10

Maximizing Utility
2. Marginal Utility per Dollar Approach

• Marginal utility per dollar is the marginal utility from a good that
results from spending one more dollar on it.

• To calculate the marginal utility per dollar for movies (or soda),
we must divide marginal utility from the good by its price.
• If the marginal utility from Movies (MUM) and the price of a
Movie (PM). Then the marginal utility per dollar from Movies is
MUM/PM.

Copyright © 2014 Pearson Canada Inc.

Copyright © 2017 Pearson Canada Inc. 6 - 10
Chapter 6, Slide
 11

Maximizing Utility
If the marginal utility from Soda (MUS) and the price of a case of
Soda (PS).
Then the marginal utility per dollar from Soda is
MUS/PS
Utility-Maximizing Rule

Spend all the available income

Equalize the marginal utility per dollar for all goods

MUM/PM = MU /P S S

MUM/MUS = PM/PS
Copyright © 2017 Pearson Canada Inc. 6 - 11
Chapter 6, Slide
 12

Maximizing Utility
Let’s apply the basic idea of Marginal Utility per Dollar

The table in Fig. 8.3 shows Marginal Utility per Dollar for Lisa.

Source: Microeconomics, 11th Edition, 2014, Michael Parkin, Pearson Higher Education, USA

Copyright © 2017 Pearson Canada Inc. 6 - 12

 The Consumer’s Demand Curve (1 of 2)
What happens when there is a change in the product’s price?

If the price of Move (M) rises, then at the previous utility-

maximizing point:

MU / P < MU / P
M M S S

To restore the equality, the consumer reduces consumption

of Move.

Copyright © 2017 Pearson Canada Inc. 6 - 13

6.2 Income and Substitution Effects of Price Changes

When price of a product change, It has two effects

The Substitution Effect

The substitution effect is the change in the quantity of a

product demanded resulting from a change in its relative
price (holding real income constant).

The substitution effect increases the quantity demanded of a

product whose price has fallen and reduces the quantity
demanded of a product whose price has risen.

Copyright © 2017 Pearson Canada Inc. 6 - 14

The Income Effect
The income effect is the change in the quantity of a product
demanded resulting from a change in real income (holding
relative prices constant).

The income effect leads consumers to buy more of a product

whose price has fallen, provided that the product is a normal
good.

The size of the income effect depends on the amount of

income spent on the product whose price changes and on
the amount by which the price changes.

Copyright © 2017 Pearson Canada Inc. 6 - 15

The Slope of the Demand Curve (1 of 2)
• The substitution effect leads consumers to increase their
demand for all normal goods whose prices fall.

• The income effect leads consumers to buy more of all

normal goods whose prices fall.

• Because of the combined operation of the income and

substitution effects, the demand curve for any normal good
will be negatively sloped.

• A fall in price will increase the quantity demanded.

Copyright © 2017 Pearson Canada Inc. 6 - 16

 The Slope of the Demand Curve (2 of 2)
A good is Giffen good when its demand increased as its price
increases.
Example: If the price of an essential food staple, such as rice,
rises it may mean that consumers have less money to buy more
expensive foods, so they will actually be forced to buy more rice. 
Products with a positively sloped demand curves are Giffen
goods.

Giffen goods have two key characteristics:

1. The good must be an inferior good—a reduction in real

income leads households to purchase more of that good
2. The good must take a large proportion of total household
expenditure and therefore have a large income effect
Copyright © 2017 Pearson Canada Inc. 6 - 17
Figure 6-3 Income and Substitution Effects of a Price Change

Copyright © 2017 Pearson Canada Inc. 6 - 18

 Conspicuous Consumption Goods
Some products are consumed not for their intrinsic qualities
but because they have “snob appeal”.

Does this behaviour violate our theory of utility maximization?

• Snobs would still buy more at a lower price as long as
other people thought they had paid a high price.
• If such consumption exists, it is unlikely the market
demand curve is positively sloped. Lower-income
consumers would buy inexpensive diamonds or BMWs.
Their behavior would likely offset the behaviour of the
relatively few higher-income “snobs”.

Copyright © 2017 Pearson Canada Inc. 6 - 19

 6.3 Consumer Surplus
Let the price of milk is $1 per liter
Litres of Milk Amount Moira is Willing to Moira’s Consumer Surplus If
Moira Consumes/Week Pay/Litre She Actually Pays $1/Litre

First $ 6.00 $ 5.00

Second 3.00 2.00
Third 2.00 1.00
Fourth 1.60 0.60
Fifth 1.20 0.20
Sixth 1.00 0.00
Seventh 0.80 --
Eighth 0.60 --
Ninth 0.50 --
Tenth 0.40 --

Copyright © 2017 Pearson Canada Inc. 6 - 20

Figure 6-4 Consumer Surplus on Milk Consumption

Consumer surplus on
each unit consumed
is the difference
between the market
price and the
maximum price that
the consumer is
willing to pay to
obtain that unit.

Copyright © 2017 Pearson Canada Inc. 6 - 21

 Consumer Surplus (1 of 2)
• Consumer surplus is the difference between the total value
that consumers place on all units consumed of a product
and the payment that they actually make to purchase that
amount of the product.
• The area under the demand curve shows the total value a
consumer places on a good.
• The market demand curve shows the valuation that
consumers place on each unit of the product.
• For any given quantity, the area under the demand curve
and above the price line shows the consumer surplus
received from consuming those units.

Copyright © 2017 Pearson Canada Inc. 6 - 22

Consumer Surplus (2 of 2)
Total consumer Figure 6-5 Consumer Surplus for the
surplus is the area Market
under the demand
curve and above the
price line.
The area under the
curve shows the total
valuation that
consumers place on
all units consumed.

Copyright © 2017 Pearson Canada Inc. 6 - 23

 The Paradox of Value (1 of 3)
Early economists and philosophers encountered the paradox
of value.
Why is it that water, which is essential to life, has a low price,
while diamonds, which are not essential to life, have a high
price?
Early economists thought the price or “value” of a good
depended only on the demand by consumers.

Copyright © 2017 Pearson Canada Inc. 6 - 24

 The Paradox of Value (2 of 3)
This view ignores two important aspects of the determination
of price.
1. Supply plays just as important a role as demand in
determining price.
2. Consumers purchase units of a good until the marginal
value of the last unit purchased is equal to its market
price.
So water has a plentiful supply, and hence a low price;
diamonds have a relatively scarce supply and hence a high
price.

Copyright © 2017 Pearson Canada Inc. 6 - 25

 The Paradox of Value (3 of 3)
• Since water has a low price, consumers buy water to the
point where the marginal value placed on the last unit
consumed is very low, and the total value is high.
• Since diamonds have a high price, consumer buy
diamonds to the point where the marginal value placed on
the last unit consumed is very high, and the total value is
low.
• So water has a low price, a low marginal value, and a high
total value.
• Diamonds have a high price, a high marginal value, and a
low total value.

Copyright © 2017 Pearson Canada Inc. 6 - 26

 Figure 6-6 Resolving the Paradox of Value

Water has a high total value and a low price, which leads to a
large consumer surplus. Diamonds have a low total value and a
high price, which leads to a small consumer surplus.
Copyright © 2017 Pearson Canada Inc. 6 - 27
 Assignment 2

Copyright © 2017 Pearson Canada Inc. 6 - 28

 Exercise
Consider the following common scenario.
An economist is attending a conference in an
unfamiliar city. She is in the mood for a high-
quality dinner and wanders through the center
of the city looking for a restaurant. After
narrowing her search to two establishments
located on the same block, she ultimately
selects the restaurant with the higher prices.
What might account for this behaviour?

Copyright © 2017 Pearson Canada Inc. 6 - 29

 LA5

Suppose there is a I0 percent increase in the prices of

the following products. Keeping in mind how large a
fraction of a typical consumer's budget these items are,
explain whether you think the income effect in each
case would be small or large, and why.
• a. salt b. jeans
• c. canned vegetables d. gasoline
• e. rental apartments g. luxury cars
• h. cell phones I. vacations to Cuba
• j. fee for one day car rentals

Copyright © 2017 Pearson Canada Inc. 6 - 30

 Exercise

Tim buys 2 pizzas and sees 1 movie a week when he has $16
to spend. The price of a movie ticket is $8, and the price of a
pizza is $4. Draw Tim’s budget line. If the price of a movie
ticket falls to $4, describe how Tim’s consumption possibilities
change.

Copyright © 2017 Pearson Canada Inc. 6 - 31

 Important Websites for more learning
• Paradox of value

• https://www.youtube.com/watch?v=T4sDB5TdWIM

• https://www.youtube.com/watch?v=rCrMapJ9gyA

Copyright © 2017 Pearson Canada Inc. 6 - 32