183
Chapter 20 (7 Micro)
Consumer Choice and Elasticity
OUTLINE
I. The Fundamentals of Consumer Choice
A. Fundamentals of Consumer Choice
2. Consumers make choices purposefully.
4. Consumers must make decisions without perfect information, but knowledge and
past experience will help.
1. As the rate of consumption increases, the marginal utility derived from
consuming additional units of a good will decline.
II. Marginal Utility, Consumer Choice, and the Demand Curve of an Individual
A. The Demand Curve
1.
consumer would be willing to pay for that unit its marginal benefit.
3.
and thus the height of their demand curve, falls with the rate of consumption.
B. Consumer Equilibrium with Many Goods
1. Consumer will maximize his/her satisfaction by ensuring that the last dollar spent
on each commodity yields an equal degree of marginal utility.
C. Price Changes and Consumer Choice
1. The demand curve shows the amount of a product that consumers would be willing
to purchase at alternative prices during a specific time period.
3. Reasons for downward slope of demand curve.
a. Substitution effect: as the price of a product declines, consumers buy more of it
and less of other now more expensive products.
D. Time Cost and Consumer Choice
1. The monetary price of a good is not always a complete measure of its cost to the
consumer.
2. Consumption of most goods requires time as well as money; and time, like money,
is scarce to the consumer.
184 Chapter 20 (7 Micro)/Consumer Choice and Elasticity
III. Market Demand Reflects the Demand of Individual Consumers
A. Individual and Market Demand Curves
IV. Elasticity of Demand
A. Elasticity of Demand
1. Price elasticity reveals the responsiveness of the amount purchased to a change in
price.
B. Determinants of Price Elasticity of Demand
1. Availability of substitutes.
2. Share of total budget expended on product.
C. Time and Demand Elasticity
1. 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.
a. Thus, the demand for most products will be more elastic in the long run than in
the short run.
b. This relationship is often referred to as the second law of
demand.
V. How Demand Elasticity and Price Changes Affect Total Expenditures (or Revenues)
on a Product
A. When the demand for a product is elastic, a price change will cause total spending on it
VI. Income Elasticity
A. Income Elasticity
1. Income elasticity indicates the responsiveness of the demand for a product to a
change in income.
2. A normal good is any good with a positive income elasticity of demand.
VII. The Price Elasticity of Supply
A. Price Elasticity of Supply
1. The price elasticity of supply is the percent change in quantity supplied divided by
the percent change in the price causing the supply response.
OBJECTIVES
This chapter focuses on the demand for specific products. The basic postulates of demand theory
are presented. The downward-sloping individual demand curve for a specific product merely
reflects the law of diminishing marginal utility. Since the market demand is the horizontal sum of
the individual demand curves, it, too, will be a downward-sloping curve.
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Students should be familiar with Chapter 3 before Chapter 20 is assigned. Instructors who have
2. The demand curve simply isolates the impact of a change in price on the quantity demanded,
assuming that other factors are unchanged. A change in price will alter the amount demanded.
3. Discuss the relationship between the mutual gains from trade introduced in Chapter 2 and
consumer surplus. Explain that the difference between the maximum price that the buyer–
5. Students have trouble distinguishing between the terms elastic and inelastic. An elastic demand
inflexible) to a change in price, we say that it is inelastic. Thus, the meaning of the words is
6. Referring to the text, discuss the estimated coefficients of demand elasticity presented in
7. Many instructors will want to explain the difference between arc elasticity and point elasticity.
The chart below provides a hypothetical example that might be used to clarify this distinction.
Amount Demanded Total Revenue
Price of Shirts (weekly) (weekly)
$5 100 $500
6 90 540
7 75 525
8. Students often confuse elasticity with the slope of the line. Since elasticity is a relative concept,
it will vary for a straight line. This point is illustrated clearly in Exhibit 4.
9. The Critical Analysis questions at the end of this chapter may be used in a variety of ways.
10. The addendum provides coverage of indifference curves for those instructors wishing to
11. It is worthwhile to try games 1 to 5 so that students will better see not only the tools involved
but also the power and wide range of useful applications for these tools.
12. It is worth emphasizing to students that elasticity questions are just extensions of supply and
13. Since a lot of new technical terms are beginning to be thrown at students in this chapter, this is
a good time to emphasize that economics, like every other scientific field, has a specialized
language because certain forms of preciseness are crucial to the proper application of the
principles involved (e.g., changes in demand versus changes in quantity demanded). It is
necessary for students to understand this specialized language, but they also need to be able to
explain what they mean in non-specialized language (e.g., can they explain their analysis to a
plumber?).
14. It is important to stress to students that indifference curves are not something totally different
GAMES
1. How the Ball Bounces
Type: In-Class demonstration
Topics: elastic, inelastic
Textbook: Chapter 19 Demand and Consumer Choice
Materials Needed: –
s
carry them.
Time: 1 minute
Class limitations: works in any size class
Purpose
This quick, but memorable, demonstration can be used to introduce the concepts of elastic and
inelastic.
Instructions
Bring two students to the front of the class. Give each of them a ball and ask them to bounce it off
2. Ranking Elasticities
Type: In-Class assignment
Topics: the determinants of price elasticity of demand
Textbook: Chapter 19 Demand and Consumer Choice
Materials needed: none
Time: 20 minutes
Class limitations: works in any size class
Purpose
The intent of this exercise is to get students to think about varying degrees of elasticity and to
think about the factors that determine demand elasticity
Instructions
Give the students the following list of goods. Ask them to rank them from most to least elastic.
If they have difficulty, these hints can be helpful:
1. How much would a 10 percent price increase for the good affect a consumers total
budget?
2. What substitutes are available for the good?
3. Do consumers think of this good as a necessity or a luxury?
Common answers and points for discussion
A typical ranking:
1. European vacation (luxury, many other vacation destinations, expensive)
2. Honda Accord (expensive, many substitutes including used cars)
3. The Utility Meter
Type: In-Class Demonstration
Topics: diminishing marginal utility, increasing total utility
Textbook: Chapter 19 Demand and Consumer Choice
Materials Needed:
box with a wire sticking out of it. Electronic components can be added for
realism.)
Time: 15 minutes
Class limitations: works in any size class
Purpose
This activity demonstrates how economists view consumption. The idea of diminishing marginal
utility is vividly illustrated.
Instructions
Place one donut, the apple, and the utility meter on a table. Explain that the utility meter measures
satisfaction, or happiness, from consuming a good. More specifically it shows the marginal utility,
or the happiness from consuming an additional unit of a good.
Chapter 20 (7 Micro)/Consumer Choice and Elasticity 189
ld get 10 units of
satisfaction from consuming the apple. This means the donut would give me three times more
from consuming various goods, we could allocate goods to maximize social well–
trying to compare numbers for different people. I have adjusted my meter; now the meter shows
met
Place the other two donuts on the table. Explain that economists are interested in how satisfaction
changes as consumption increases. Put a chart on the board with these headings
Quantity Marginal Utility Total Utility
0 0
1
2
3
a utility reading of 300. This means the marginal utility from consuming any one of the donuts is
300.
Eat a donut. Fill in 300 units of satisfaction for the marginal utility from the first donut.
Quantity Marginal Utility Total Utility
0 0
1 300 300
2
3
Eat the second donut. Record the marginal utility and calculate the total utility from consuming
the two donuts.
Quantity Marginal Utility Total Utility
0 0
190 Chapter 20 (7 Micro)/Consumer Choice and Elasticity
Fill in the final Marginal and total utilities.
Quantity Marginal Utility Total Utility
0 0
Points for discussion
Utility comparisons give the relative satisfaction from consuming one good versus another good.
themselves feel worse.
Type: In-Class activity
Topics: budget constraints
Textbook: Chapter 19 Demand and Consumer Choice
Materials Needed: none
Time: 5 minutes
Class limitations: works in any size class
Purpose
This activity shows consumers are restricted by their limited incomes and by the prices of goods.
Instructions
Ask the students to think about maximizing their own utility.
Specifically, ask them to assume that billionaire Bill Gates offers to buy them the one thing that
instrument, but he will buy them any single thing they feel would make them happy. Have them
write their requested item.
Ask a f
chases are constrained by their
incomes.
Chapter 20 (7 Micro)/Consumer Choice and Elasticity 191
next to the item. Now, have them assume Bill Gates is too busy to go shopping, so he gives them
the money inste
them maximize their happiness.
This eliminates the income barrier. Ask the class how many of them would spend the entire
amount of money buying that single good.
Some students would buy that item, but most would buy a variety of things. Using the money for
a single expensive item may not be the best way to allocate their newfound wealth. Buying several
cheap things may give a higher level of happiness.
Points for discussion
2) Goods have prices.
5. Do Something New
Type: Take-home Assignment
Topics: Consumer choice
Textbook: Chapter 19 Demand and Consumer Choice
Class limitations: works in any size class
Purpose
This assignment helps students relate the abstract ideas of consumer theory and optimization to
their own lives. The first part asks them to speculate about the kinds of things that make people
happy. The second part asks them to do something they feel would increase their happiness.
Instructions
Ask the students to complete the following assignment. Explain that Part 1 is contemplative and
that Part 2 is active. The new activity does not have to be exotic or expensive.
Points for discussion
Consumer satisfaction and utility can be increased by things other than narrowly defined, material
–
increases
Imperfect information makes consumer decisions difficult. Some students may try activities and
not like them, or find the initial costs are higher than the benefits. This can be used to introduce
decision-making under uncertainty or to introduce information problems.
192 Chapter 20 (7 Micro)/Consumer Choice and Elasticity
Name _________________________________ Course __________________
Utility and Consumer Behavior
Consumer theory focuses on maximizing individual satisfaction. This assignment gives an
opportunity to consider activities and experiences you feel would increase your personal utility.
Part I.
For each of the
experienced.
1. Travel destination. Where would you like to go?
2. Volunteer. What group would you like to help?
3. Activity. What would you like to try?
4. Personal Goals. What would you like to accomplish?
Part II.
Do something new. Choose an activity that you have never done before, but one you want to try.
It can be anything you like, as long as you feel it would be enjoyable. It does not have to be an
activity you listed in Part I.
Part III.
Do it.
Part IV.
Report on your activity. What did you do? What were the costs involved in your activity? Did it
meet your expectations? Would you recommend it to your classmates?
Chapter 20 (7 Micro)/Consumer Choice and Elasticity 193
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
1. Revenue will rise (fall) if students who enroll pay more (less) extra revenue than is lost due to
4. The consumer is not maximizing her utility. The marginal utility of a dollar spent on jeans is 2
8. Consumption of medical services increases. Some units valued less than their costs will be
consumed. (Assume positive marginal costs that are constant, and use graphic demand and
cost analysis to illustrate this point.) In addition, you might want to ask your class to consider
lowing
questions: How would this method of organization influence absenteeism? Might it lead to
same problems present with medical insurance?
9. All three statements are true.