PHHA 326: Health Economics Chapter 3 Update PDF

PHHA 326: HEALTH ECONOMICS CONTENT Consumer Choice Budget Line Preferences - Utility , Max, Total, Diminishing Marginal utility theory of consumer choice Utility Max Choices Prediction using marginal utility theory price and income changes Rise in income, good , alte...

PHHA 326: HEALTH ECONOMICS CONTENT Consumer Choice Budget Line Preferences - Utility , Max, Total, Diminishing Marginal utility theory of consumer choice Utility Max Choices Prediction using marginal utility theory price and income changes Rise in income, good , alternative good New ways of explaining consumer choices 3 CONSUMER CHOICE, CONSUMPTION POSSIBILITIES AND DEMAND CONSUMER CHOICE AND DEMAND 4 If you demand something, then you 1. Want it, 2. Can afford it, and 3. Have made a definite plan to buy it. quantity demanded is ? 5 CONSUMERS CHOICE & DEMAND & TYPE OF GOODS ▪ Normal Goods ▪ Inferior Goods ▪ Substitutes ▪ Complements ▪ What happens to Qd when prices of these increase? What happens to Qd when prices of these decrease? CONSUMPTION CHOICES 6 2. Consumer’s Preference Utility, Choices - rational people – decision making Economist use the concepts of Utility – the satisfaction or happiness or benefit people derive from consuming goods and services. Utility Maximization – goal, assume people try to allocate their income to maximize their satisfaction Total Utility (TU)- utility people derive from all their consumption activities. Marginal utility (MU)- The additional utility gained from consuming an additional unit of a good (or service) 7 CONSUMPTION CHOICES Utility Max Choices of consumers influenced by two factors 1. Consumption Possibilities ( Budget) What consumers can afford 2. Consumer Preferences (Utility) Description of Likes and Dislikes Brings in utility and marginal utility Lets go to a model.. 8 CONSUMPTION CHOICES 1. Consumption Possibilities defined via Budget Line The line Defines boundary between those shows all combinations of goods and services possibilities for the consumer can and cannot afford consumer Budget constrains choices: Points on the budget line and inside the budget line affordable Points beyond the budget line are not affordable 9 CONSUMPTION CHOICES 1. Consumption Possibilities defined via Budget Line Changes to Consumer’s Budget Line and thus Consumption the line Possibilities Changes when income or prices changes possibilities change. increase in income - rightward shift without changing its slope. change in the price of one of the goods - intercept on its axis and thus slope of the budget line changes. 10 CONSUMPTION CHOICES OK – now you know possibilities but how do you decide on what combo? How many Pizza and how many books? 11 CONSUMPTION CHOICES 2. Consumer’s Preference The choice a consumer makes depends on preferences and the need to max utility Decided using marginal utility CONSUMPTION CHOICES 12 2. Consumer’s Preference Utility – ? Where do we get these numbers? Pizza – one slice 25 units of utility then…… EXAMPLE 13 CONSIDER THE HAMBURGER EXAMPLE FIRST HAMBURGER - TASTE GREAT… 14 CONSUMPTION CHOICES So we experience Diminishing Marginal Utility As the consumption of a good increases additional utility gained from an extra unit of the commodity tends to decline E.g. the second hamburger eaten gives more utility than the 6th hamburger eaten 15 CONSUMPTION CHOICES Consumption choice depend on : 1. Consumption Possibilities (Budget) 2. Consumer Preferences (Utility ) consumers make Utility-Maximizing Choice And Consumer Equilibrium & Optimal Consumption results consumer has allocated all available income in a way that maximizes utility given the prices of the products. EXAMPLE 16 As Lisa sees more movies in a month, her total utility from movies increases. As the number of movies seen in a month increases, marginal utility from movies decreases. EXAMPLE 17 Graph it..total utility EXAMPLE 18 Graph it..marginal utility 19 UTILITY-MAXIMIZING CHOICE: TWO METHODS Spreadsheet solution Choose at the margin 20 UTILITY-MAXIMIZING CHOICE Option 1: Spreadsheet Solution Decision - select combo of goods with max total utility Define utility..goods.. Excel etc. 21 UTILITY-MAXIMIZING CHOICE Option 1: Spreadsheet Solution Consumer Equilibrium Choose combination that gives highest total utility. 90 units of utility from the 2 movies and 225 units of utility from the 6 cases of pop.  UTILITY-MAXIMIZING CHOICE 22 Option 2: Choosing at the Margin Decision is.. Would spending a dollar more or a dollar less on a good bring more total utility? Consumer Equilibrium - consumer spends all available income and equalizes marginal utility per dollar for all goods. MUM/PM and MUP/PP , Called the Rational Spending Rule 23 NEW WAYS OF EXPLAINING CONSUMER CHOICES 1 Behavioural Economics Behavioural economics studies the ways in which limits on the human brain’s ability to compute and implement rational decisions influences economic behaviour—both the decisions that people make and the consequences of those decisions for the way markets work. There are three impediments to rational choice: Bounded rationality Bounded willpower Bounded self-interest 24 NEW WAYS OF EXPLAINING CONSUMER CHOICES Behavioural Economics Bounded rationality rationality that is bounded by the computing power of the human brain. Faced with uncertainty, consumers cannot rationally make choices and instead rely on other decision-making methods such as rules of thumb, listening to the views of others, or gut instinct. 25 NEW WAYS OF EXPLAINING CONSUMER CHOICES Behavioural Economics Bounded will-power less-than-perfect willpower that prevents us from making a decision that we know, at the time of implementing the decision, we will later regret. Bounded Self-Interest limited self-interest that sometimes results in suppressing our own interests to help others. Main applications are in finance where uncertainty is the key factor and savings where future is the key factor. 26 QUESTIONS How do consumers make choices? What influences the preferences? Budget line? How is consumer choice linked to demand schedules? Would people voluntarily pay for something seemingly undesirable? How exactly does the rational spending rule work? How does price or income change influence choice? consumption? Graph it! The marginal utility curve for a “necessity” is vertical line Why? Explain. Hint.. where no increase in price is sufficiently large to cause the person to decrease consumption of a necessity 27 QUESTIONS Explain how a consumer’s income and the prices of goods limit consumption possibilities. What is utility and how do we use the concept of utility to describe a consumer’s preferences? What is the distinction between total utility and marginal utility? What is the key assumption about marginal utility? Any contrary examples? What two conditions are met when a consumer is maximizing utility? What is the marginal utility per dollar and how is it calculated? Explain why equalizing the marginal utility per dollar for all goods maximizes utility.