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Fundamentals of
Consumer Choice
ï

   :
rs the rate of consumption increases, the
marginal utility derived from consuming
additional units of a good will decline.
@arginal Utility, Consumer
Choice, and the Demand
Curve of an Individual
he Demand Curve
h he height of an individual's demand curve
indicates the maximum price the consumer
would be willing to pay for that unit.
h r consumer's willingness to pay for a unit
of a good is directly related to the utility
derived from consumption of the unit.
h he

   
implies that a consumer's marginal benefit,
and thus the height of their demand curve,
falls with the rate of consumption.
 he Demand Curve
h rn individual¶s demand curve,
Jones¶s demand for frozen pizzas Jones¶s  
in this case, reflects the law of for frozen pizza
diminishing marginal utility.
@ 
h
ecause marginal utility (@) falls _
.50
with increased consumption, so does @ 
_
.00
a consumer¶s maximum willingness
to pay -- marginal benefit (@ ). Ñ @ 
_ .50


h r consumer will purchase until @

@  Ñ . . . so at _ .50 Jones _ .00
would purchase
frozen pizzas and
receive a consumer surplus shown
by the shaded area (above the O  @
line and below the demand curve).

@
@  @  @  Frozen pizzas

 
4 per week
@
 @  @  @
Individual and @arket Demand Curves
h Consider u ¶s demand for frozen pizza. rt _
.50 u
   pizza « at _ .50
pizzas « and so on «
h Consider 
¶s demand for frozen pizza. rt _
.50 

  pizzas « at _ .50
pizzas « and so on «

h he    is merely the horizontal sum of the
individual demand curves (here u and 
).
h he    will slope downward to the right,
just as the individual demand curves do.
u 
Ñ  

_
.50 _
.50 _
.50

_ .50 _ .50 _ .50





4 5  7  
4 5  7  
4 5  7 
 O  O
ulasticity of Demand
Ñrice ulasticity of Demand
h Ñrice elasticity reveals the responsiveness of
the amount purchased to a change in price.
‰ 
Ñ 
   ‰Œ
   ‰ 
   ‰Œ

( 0  ) ( Ñ0 Ñ )

( 0 å  ) ( Ñ0 å Ñ )
   

( 0  ) ( 0 å )

(
0
 ) (
0 å
)
Ñrice ulasticity Numerical rpplication
h uppose rina bakes specialty cakes. he can sell
50 specialty cakes per week at _7 a cake, or 70
specialty cakes per week at _ a cake.
h hat is the demand elasticity for rina¶s cakes?
Ñ
 ( 50 70 ) 0




.

%
   ( 50 å 70 ) 0

Ñ
 (7 ) 


5 .
 %
O (7 å )  .5

Ä
O  ‰Œ 
  
   ‰Œ

 
Ñ  ( 0  ) (
0
 )
   ( å ) (
0 å
 )
0 
Ñrice ulasticity of Demand
h rfter calculating the price elasticity of
demand, you can determine whether it is
elastic, inelastic, or unitary elastic with the
following chart:
h If the absolute value of the elasticity term < ,
then the demand is  .
h If the absolute value of the elasticity term > ,
then the demand is  .
h If the absolute value of the elasticity term = ,
then the demand is   .
h
ecause price elasticity of demand is  
negative, the sign on the coefficient is often
omitted in discussions of elasticity.
 ulasticity of Demand
h Ñ  :
@ythical rn increase in price results in no
demand change in consumers purchases.
curve
he vertical demand curve is
mythical as the substitution and
income effects prevent this from
Quantity/ happening in the real world.
(a) time

h    

r percent increase in price results Demand for
Cigarettes
in a smaller reduction in sales.
he demand for cigarettes has
been estimated to be highly
inelastic.
Quantity/
(b) time
 ulasticity of Demand
h   :
Demand curve of he percent change in quantity
unitary elasticity demanded due to an increase in
price is equal to the change in
price. r decreasing slope
results. ales revenue (price
Quantity/ times quantity) is constant.
(c) time
 ulasticity of Demand
h    :
Demand for r increase in price leads to a
Granny mith
apples larger reduction in purchases.
hen there are good substitutes
for a product (as with Granny
mith apples), the quantity
purchased will be highly
Quantity/ sensitive to changes in price.
(d) time

Demand for Farmer

h Ñ   Hollings¶s wheat
Consumers will buy all of Farmer
Hollings¶s wheat at the market
price, but none will be sold above
the market price.
Quantity/
(e) time
 ulasticity of Demand
( ) ( 0 å )
 0

(
0


 ) (
0 å
 )

(0 - 00) (0 + 00)

h ith this straight-line (constant-slope) (_ - _ ) (_ + _ )
demand curve, demand varies across
a range of prices.
 ( - ) 0.4
u     (-) 0.4
h Using the equation for elasticity, the
formula shows that, when price rises
from _ to _ « while quantity
demanded falls from 0 to 00 «
the elasticity for that region of the
demand curve is ( - 0.4 ) ± inelastic.



Quantity
00 0 demanded
 ulasticity of Demand
( ) ( 0 å )
 0

( Ñ0


Ñ ) ( Ñ0 å Ñ )

( 0 - 0) ( 0 + 0)
h r price increase of the same amount, (_0 - _) (_0 + _)
from _0 to _, . . . leads to a decline  (-) 7.0
in quantity demanded from 0 to 0. 
0 u     (-) 7. 0
h Note that this change in price was
smaller (as a ) than in the previous
slide but resulted in the same change
in quantity demanded.
h rpplying the elasticity formula, the
calculated elasticity is (- 7.0) ± greater
than (- 0.4) from before.
h he price-elasticity of a straight-line
demand curve increases as price rises. 
Quantity
0 0 demanded
 
 
  


  !


|
Determinants of
Ñrice ulasticity of Demand
h rvailability of  
h hen good substitutes for a product are
available, a rise in price induces many
consumers to switch to another product.
h he greater the availability of substitutes,
the more elastic demand will be.
h 
  expended on product
h rs the share of the total budget spent on the
product increases, demand is more elastic.
 ulastic and Inelastic Demand
Ñrice Ñrice

_.50 _.50

_.00 _.00



5 00 0 00
Œ"
allpoint pens per week Œ  Œ" Cigarette packs per week Œ   
h rs the price of ballpoint pens (a) rises from _.00 to _.50 . . . the
quantity demanded plunges from 00,000 to 5,000 per week.
h he reduction in quantity demanded is larger than the increase in
price, hence the  for ballpoint pens is relatively  .
h rs the price of cigarettes (b) rises from _.00 to _.50 . . . quantity
demanded declines from 00 million to 0 million packs per week.
h he reduction in quantity demanded is smaller than the increase
in price, hence the   for cigarettes is relatively  .
ime and Demand ulasticity
h If the price of a product increases,
consumers will reduce their consumption
by a larger amount in the long run than in
the short run.
h hus, demand for most products will be more
elastic in the long run than in the short run.
h his relationship is often referred to as the

 .
How Demand ulasticity and
Ñrice Changes rffect otal
uxpenditures Π
on a Ñroduct
Ä 

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 otal uxpenditures
and Demand ulasticity
Impact of

O Impact of 
O
ulasticity on total consumer on total consumer
Ñrice elasticity coefficient expenditures or a expenditures or a
of demand (in absolute value) firm¶s total revenue firm¶s total revenue

   to  decrease increase

Unitary ulastic  -- unchanged-- -- unchanged--
  0 to  increase decrease

h he table above summarizes the relationship

between changes in price and total expenditures
for demand curves of varying elasticity.
Income ulasticity
Income ulasticity
h   indicates the responsiveness
of a product¶s demand to a change in income.
‰ 
 
  
   ‰ !

h r   is a good with a positive

income elasticity of demand.
h rs income expands, the demand for normal
goods will rise.
h Goods with a negative income elasticity are
called  .
h rs income expands, the demand for inferior
goods will decline.
|  
 

h Change in price of some other good Y
may affect demand for X
h @easure size of effect using cross
elasticity of demand
h Ñercent change in consumption X
divided by the percent change in the
price of Y
h ubstitutes: cross price elasticity of
demand positive
h Complements: cross price elasticity of
demand negative
Ñrice ulasticity of upply
Ñrice ulasticity of upply
h he O  OO  is the percent
change in quantity supplied divided by the
percent change of the price causing the
supply response.
h analogous to the O  
h However, the price elasticity of supply will
be positive because the quantity producers are
willing to supply is directly related to price.
Questions for hought:
. (a) tudies indicate that the demand for Florida
oranges,
ayer aspirin, watermelons, and
airfares to uurope are elastic. hy?
(b) hy is the demand for salt, matches, and
gasoline Œ inelastic?
. rre the following statements "?
uxplain your answers.
(a) r 0 reduction in price that leads to a 5
increase in amount purchased indicates a
price elasticity of more than .
(b) r 0 reduction in price that leads to a 
increase in total expenditures indicates a
price elasticity of more than .
Ä%|


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!

h
udget constraint line shows all the
different combinations of the two
commodities that a consumer can
purchase, given his money income and
the prices of the two commodities.
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h rn indifference curve shows the
various combinations of commodity X
and Y which yield equal utility to the
consumer. r higher indifference curve
show a greater amount of utility,
compared to a lower indifference
curve.
h Cannot intersect, and usually convex,
and negatively sloped
 
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ð = ð( , )
taking the total differential
dð = ð d + ð d
dð = 0, to hold utility constant
0=ð d +ð d .

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 ð A  . ð
Consumer uquilibrium
ith @any Goods
h uach consumer will maximize his/her
satisfaction by ensuring that the last dollar
spent on each commodity yields an equal
degree of marginal utility.

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@arket Demand Reflects
the Demand of Individual
Consumers

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Note: rgain,
utility rises as
m
 
   price falls.

Here, we get
 an upward

sloping
 Demand


  
 
  
 
 
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h If price of X increases, quantity
demanded decreases
h Follows law of demand
h Goods called non-Giffen goods
h If price of X increases, quantity
demanded increases
h iolates law of demand
h Goods called Giffen goods
 
  #)
h rs @r. Giffen has pointed out, a rise in the
price of bread makes so large a drain on the
resources of the poorer labouring families
and raises so much the marginal utility of
money to them, that they are forced to curtail
their consumption of meat and the more
expensive farinaceous foods: and, bread
being still the cheapest food which they can
get and will take, they consume more, and
not less of it.
 
  #)
h Gasoline, in certain circumstances, may act as a
Giffen good. Increases in gasoline prices, may force
poor drivers to devote more money to gasoline that
they otherwise might have spent on oil changes, tune-
ups, minor repairs, or even upgrades to more fuel-
efficient vehicles. rs a consequence, their "older, less
well-maintained cars" may have "decreased gas
efficiency", resulting in an increase in gasoline
consumption. (rbramsky, 005, ) his corresponds
to the Giffen model, with maintenance and upgrades
constituting the superior goods and gasoline the
inferior Giffen good.
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