Discuss the principle of rational choice and the principle of diminishing marginal utility.
The principle of rational choice accounts for the laws of demand and supply.
Discuss why three assumptions of the theory of choice may not reflect reality.
It's Friday night and you've managed to save $50 to take a break from classes and buy two tickets, one for yourself and one for a friend, to see the rock concert at the field house.
You might consider going to a movie and having a hot fudge sundae after for the two of you.
Or maybe ordering a meal.
The money could be given to the homeless shelter.
You have choices all the time.
Microeconomics deals with how individuals make choices.
It gives economics a lot of its power.
The first part of this chapter shows you the basics and leads you through some exercises to understand the reasoning.
The second part of the chapter gives you a sense of when the model is useful and when it's not.
The goals for this book were set in Chapter 1.
One goal was to make you think like an economist.
The reasoning process behind economists' cost/benefit approach to problems is developed in this chapter.
A group of economists, called behavioral economists, have explored the different sciences and their deviations from rationality and self- interest.
The building blocks of economics have been expanded.
Freudian psychology tells us that an internal complicated model is much more difficult to use and that we have a cost.
The advantage of fight between the id, ego, and superego using traditional building blocks is that it allows you to decide whether the model is bodies or not.
It's not applicable according to other psychologists.
Behavioral economists recognize the cost and are trying to be ok.
The work is still in an early stage and they have a long way to go.
Most economists agree that the best place to start is with get us all mixed up.
The models are based on the traditional building blocks.
The underlying psychologi book should be simpler because it focuses on models with the traditional cal foundation.
Calculating self-interest is one of the building blocks of economists' research.
People are doing what economists are doing.
Economists' traditional analysis of individual choice doesn't deny that most of us have quirks.
We're penny pinchers on certain items and big spenders on others.
Through it all, there is a certain rationality.
The rational self-interest of many people is reflected in what they do.
That's why economists begin their analysis of individual choice with a psychological foundation.
The market uses price to bring the quantity supplied equal to the quantity demanded.
Understanding how price affects our choices is what economics is all about.
The effect of price on quantity demanded is what we focus on.
We want to know how a change in price will affect us.
The economists' theory of rational choice shows howpleasure and price are related.
As consumption increases, marginal utility decreases.
There are two ways in which total utility is presented.
The marginal utility line is graphed at the halfway point because it relates to changes in quantity.
The 4,700 is the total utility; Utility and Pleasure the 3 is the marginal utility.
Figure 19-1 shows the relationship between total utility and marginal utility.
The marginal utility of the first slice of pizza is 14 and the total utility is 14 since you only ate one slice.
The total utility of 2 slices of pizza is 26 because the marginal utility of the second slice is 12.
For the third, fourth, and fifth slices of pizza, their marginal utilities are 10, 8, and 6.
The marginal utilities you get from eating each of the 5 slices of pizza is the total utility.
To make the examples more understandable and to make the points I want to make, I choose specific numbers throughout the book.
Economists do not use actual numbers to discuss utility.
The numbers are used to make the presentation easier.
You can use an exercise to choose different numbers and reason your way through the analysis.
I use the same analysis in the appendix of the chapter.
There is a marginal utility between the rows.
Changing from 1 to 2 slices of pizza has a marginal utility of 12.
The relationship between total and marginal utility can be seen graphically.
After 8 slices of pizza, you're so stuffed that you can't look at another slice.
Utility becomes zero when there is a marginal point.
marginal utility is zero when total utility stops increasing between 7 and 8 slices.
Total utility decreases and marginal utility is negative after this point.
An extra slice of pizza will make you worse off.
With each slice of pizza eaten, the marginal utility that a person gets from each additional slice decreases.
Economists believe that the shape of these curves is a good description of the pattern of people's enjoyment.
When individuals increase their consumption of a good, they will simply not get as much pleasure from consuming another unit.
Consider that late-night craving for a pizza.
You have to bite into it.
If you've ordered a large pizza and you're eating it alone, you'll enjoy each additional slice less.
The marginal utility you get is going to decrease with each slice of pizza you consume.
It's the principle of diminishing marginal utility.
Consuming more enjoy consuming more of a good; it simply states that as you consume more of a good, you enjoy the additional units less than you did before.
marginal utility can become negative at some point.
You only had two hours to eat the pizzas.
It could be torture to eat the last slice.
Diminishing Marginal is a good sign that the marginal utility is still positive.
Rational choice is the analysis of how individuals choose goods within their budget in order to maximize total utility, and how maximizing total utility can be accomplished by considering marginal utility.
Rational people want as much satisfaction as they can get from their resources, according to the analysis.
The problem is that people have a budget constraint.
They have to choose among the alternatives.
Consider three choices.
Spending another dollar on a slice of pizza will give you an additional 41 units of utility, or spending another dollar on a cup of coffee will give you an additional 30 units of utility.
Between reading an additional chapter in this book that gives you an additional 200 units of utility at a cost of one hour of your time, or reading an additional chapter in psychology that gives you an additional 100 units of utility at a cost of 40 minutes of your time.
Between having your next date with that awesome guy Jerry, which gives you an additional 2,000 units of utility and costs you $70, or taking out plain Jeff on your next date, which gives you an additional 200 units of utility and costs you $10.
The pizza, chapter of the book and Jerry are the correct choices in terms of marginal utility.
Either you are lucky or you have a good intuitive understanding of the principle of rational choice if you answered all three correctly.
The principle of rational choice can be explored more thoroughly by considering each of the three examples.
Since the slice of pizza and the cup of coffee both cost $1, and the pizza gives you more units of utility than the coffee, the pizza is the rational choice.
If you spend $1 on coffee instead of pizza, you're losing 11 units of utility and not making yourself as happy as you could be.
Any choice that doesn't give you as much utility as possible is irrational.
If the price of coffee falls to 50 cents a cup, you can buy two cups for the same price you had to pay for one.
Remember the principle of diminishing marginal utility when you say that two cups of coffee would give you 56 units of utility.
Their 56 units of utility are 15 more than you would get from one slice of pizza, so they have two cups of coffee.
One way to think about your choice is to know that what you're doing is buying units of utility.
You want to get the most for your money, so you choose goods that have the highest units of utility per unit of cost.
Consider our second choice when thinking about a decision.
The two alternatives have a cost.
One hour of CNN gives the same analysis.
Pick the activity that has a higher marginal utility per unit of cost or a lower marginal utility per unit of cost.
The psychology chapter gives you 21/3 units of utility per minute, while this chapter gives you 31/3 units of utility per minute.
To keep the analysis simple in this example, I consider either/or decisions.
I show you how to extend the analysis to marginal choices.
I choose the numbers to make the points I want to make.
If you want to see what your rational choices are, you can choose different numbers that reflect your estimate of the marginal utility you get from a choice.
Taking out Jerry will give you 28 1/2 units of utility per dollar, while taking out Jeff will give you 20 units of utility per dollar.
Rational choice is important for us to restate.
By substituting the marginal utilities and prices of goods into these formulas, you can always decide which good it makes more sense to consume.
The one with the highest marginal utility should be consumed.
We've considered the choices separately so far.
Choices are not neatly separated in real life.
You were presented with all three choices at the same time.
The answer is no.
The pizza gives you 41 units of utility per dollar, while taking out Jerry gives you 28 1/2 units of utility per dollar.
You aren't maximizing your utility.
It makes sense to eat more pizza and pay for it by cutting the date with Jerry short.
The costs of both studying alternatives are expressed in terms of time, not money, so we can't compare them.
We can make the comparison if we can assign a money value to the time.
The value of your time is 10 cents per minute if you earn $6 an hour.
We can think about both alternatives in terms of dollars and cents.
60 minutes x 10 cents is the cost in money of reading a chapter in economics.
The cost of 40 minutes to read the psychology chapter is $4.