17 -- Part 2: Behavioral Economics and Risk Taking
There are five glaring challenges to the well-being of Mexico's citizens.
Some factors are more important than others.
Table 16.3 shows diminishing marginal utility.
If you only use pizza orPepsi, you will have a lower total utility: 60 Utils with pizza and 45 Utils withPepsi.
The preferred outcome of four Pepsis and three pizza slices corresponds to a modest amount of each good; this outcome avoids the utility reduction associated with excessive consumption of either good.
You maximize your total utility if you think about the margin of which good provides the highest marginal utility.
Most people don't think this way.
Consumers make marginal choices all the time.
Consumer choice is an instinct to seek the most satisfaction.
Generalizing the two- good example is what we will do next.
The idea of measuring utility makes sense and helps us solve simple problems.
When you travel without a gps device, you make choices about which route to take to save time.
One route will be better than the other if you turn left or right at the stop sign.
marginal thinking is what economists focus on.
Life is more complex than the model suggests.
You can choose among many goods when you have $10 to spend.
Because you buy many items at all kinds of prices over the course of a year, you have to juggle hundreds or thousands of purchases so that you enjoy roughly the same utility per dollar spent.
Consumer optimum compares the utility gained with the price paid for every item a consumer buys.
The ratio of the marginal utility per dollar spent on every item, from good A to good Z, is equal if a consumer's income or budget is balanced.
The relationship between changes in price sooner is explored in the next section.
You reached an optimum when you bought four Pepsis and three slices of pizza.
The prices of a slice of pizza and a can of soda were the same as before.
If the price of a slice of pizza drops to $1.50, then that's a good thing.
Lower prices increase the marginal utility per dollar spent and cause consumers to buy more of a good.
The marginal utility per dollar spent is lowered by higher prices.
The law of demand has been restated.
The law of demand states that when the price goes up, the quantity goes down, and when the price goes down, the quantity goes up.
It makes sense to connect the prices that consumers pay, the quantity that they buy, and the marginal utility that they receive if we think of consumer desire for a particular product as demand.
There are two effects of a lower price.
To separate these two effects, we need to go back to our previous example.
It is more affordable to buy a slice of pizza at a lower price.
If there is a change in the price, the consumer can afford six slices and still have money left over.
When the price of a slice of pizza is less than $2, your optimum is three slices.
50 cents per slice is the savings if the price of a slice of pizza is lowered to $1.50.
You can buy another slice if you purchase three slices.
The fourth slice of pizza yields an additional 8 Utils, according to column 5 in Table 16.2.
You could use the $1.50 you saved on pizza to buy a fifth can of soda and still have 50 cents left over.
Pizza has become less expensive, which may cause you to substitute it for something else.
There is a substitution effect at work.
You have more purchasing power when you save money on pizza.
The income effect is real.
When prices change enough to have a measurable effect on the purchasing power of the consumer, the real- income effect matters.
Suppose a 10% price reduction in peanut butter cups occurs.
How much money is saved is the key to answering this question.
A 10% reduction in the price of candy bars would be less than 10 cents.
Some consumers will switch to peanut butter cups because of the lower price.
The real- income effect is insignificant.
The consumer saved less than 10 cents.
The money saved could be used to purchase other goods, but very few goods cost so little, and the enhanced purchasing power is effectively zero.
The answer to the question is that there will be a small substitution effect and no real income effect.
The cost of your favorite Starbucks creation is usually $5.
Imagine how it would taste if you spent over $50 on extra shots, add- ins, and flavors.
The law of diminishing marginal utility says that more units of the same good will bring more marginal utility.
When you consider what $50 could buy instead of coffee, the effects are substantial.
$50 is enough to buy a week's worth of groceries.
It's hard to imagine that a single Starbucks drink would provide more utility than a week's worth of food.
The diamond- water paradoxes were first described by Adam Smith in 1776 and explain why water, which is essential to life, is inexpensive and diamonds, which do not sustain life, are expensive.
Many people of Smith's era found inexpensive, while diamonds do not sustain life.
Consumer choice theory can be used to answer expensive.
The diamond- water paradoxes compares the amount of marginal utility a person receives from a small quantity of something rare with the amount of marginal utility received from consuming a small amount of additional water after already consuming a large amount.
The law of demand captures marginal utility by the price of a good.
When the price of diamonds increases, the quantity demands decline.
In graphical terms, the consumer surplus is the area under the demand curve and above the price, or the gains from trade that a consumer enjoys.
Consumers will enjoy less surplus if the price of diamonds increases.
Figure 16.2 shows the market for water and the market for diamonds.
The consumer surplus is highlighted in blue and the triangular area is highlighted with dots.
The blue area of total utility for water is larger than the dotted area of total utility for dia monds because water is essential for life.
Water creates more utility than diamonds do.
In most places in the United States, water is plentiful, so people take additional units of it for granted.
If someone offered you a gallon of water right now, you would probably not take it.
It is not surprising that water would yield less marginal utility than diamonds.
The price of water would surpass the price of diamonds if it were as rare as dia monds.
We should consider how we use water.
The marginal utility of water is high because each of those uses has high value.
We use it to fill our fish tanks.
The marginal utility of water for those uses is much lower.
Water is used in both essential and non-essential ways because its price is low, so low- value uses, like filling fish tanks, yield enough utility to justify the cost.
The price of water is low because it is abundant.
Diamonds are rare and their price is high.
Diamonds are given as gifts for extremely special occasions due to the fact that a consumer must get a great deal of marginal utility from the purchase of a diamond to justify the expense.
People don't realize that demand and supply are equally important in determining the value of a good.
The demand for water is larger than the demand for diamonds.
The blue area, which is the consumer surplus for water, is larger than the dotted area, which is the consumer surplus for diamonds, because water is essential for life.
Diamonds are rare and the price is high.
They are parallel to the water paradoxes.
The key is the business model.
McDonald's is a lot like water ing food at low prices, a combination that encourages in the diamond- water paradoxes.
It's easy to find consumers to eat more than they would if the price of Mcdonald's was the same anywhere.
70 million customers a day are served by the diminishing chain.
Even though the marginal utility of an indi very little additional utility is low, it is not uncommon for vidual bite to be high.
Consumers discard excess at scale restaurants.
Consider fine dining.
The customers they serve are small.
Smaller portions are served by the total utility.
A five- course upscale restaurant is low compared with a meal that is meant to be enjoyed, but the marginal utility of an individual outweighs the price.
It's quite high for someone to be willing to pay for a meal at an upscale restaurant.
The answer is no.
Increasing income makes it easier for people to buy more goods, but diminishing marginal utility makes it harder for them to be satisfied.
People are more satisfied when they have more money.
Quality of life and money are not directly related.
Sometimes more money leads to more utility and other times it leads to more problems.
Price is a key factor in determining utility.
Consumers face a budget and want to maximize their utility, the prices they pay determine their marginal utility per dollar spent.
We can understand individuals' consumption patterns by comparing the marginal utility per dollar spent.
Diminishing marginal utility helps to describe consumer choice.
Consumers don't purchase their favorite products exclusively because marginal utility goes down.
They diversified their choices in order to get more utility.
There are two different effects on real income and a separate substitution effect that determines the composition of the bundle of goods that are purchased.
In the next chapter, we want to know how many people use consumer choice theory to make their decisions.
Behavioral economics argues that decision makers are not entirely rational about their choices.
In the appendix that follows, we refine consumer theory by removing indifference curves.
The appendix will give you a glimpse into how economists model consumer choice.
Economists model consumer satisfaction by examining utility, which is a measure of the level of satisfaction that a consumer enjoys from the consumption of goods and services.
The amount of good or service that a person will consume is limited by this property.
Consumers can find goods and services that maximize the level of satisfaction from a given income or budget by looking at the nation of goods and services.
When a consumer maximizes the utility from his or her income or budget, the marginal utility per dollar spent on every item is equal to that of every other item purchased.