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Economics: Finding Consumer Equilibrium

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About this Lesson

  • Type: Video Tutorial
  • Length: 4:48
  • Media: Video/mp4
  • Use: Watch Online & Download
  • Access Period: Unrestricted
  • Download: MP4 (iPod compatible)
  • Size: 51 MB
  • Posted: 03/29/2010

This lesson is part of the following series:

Economics: Full Course (269 lessons, $198.00)
Economics: Consumer Choice & Household Behavior (8 lessons, $13.86)
Economics: Utility Theory (2 lessons, $2.97)

In this economics tutorial, we will walk through the idea of consumer equilibrium. Taught by Professor Tomlinson, this video lesson was selected from a broader, comprehensive course, Economics. This course and others are available from Thinkwell, Inc. The full course can be found at http://www.thinkwell.com/student/product/economics. The full course covers economic thinking, markets, consumer choice, household behavior, production, costs, perfect competition, market models, resource markets, market failures, market outcomes, macroeconomics, macroeconomic measurements, economic fluctuations, unemployment, inflation, the aggregate expenditures model, banking, spending, saving, investing, aggregate demand and aggregate supply model, monetary policy, fiscal policy, productivity and growth, and international examples.

Steven Tomlinson teaches economics at the Acton School of Business in Austin, Texas. He graduated with highest honors from the University of Oklahoma and earned a Ph.D. in economics at Stanford University. Prof. Tomlinson's academic awards include the prestigious Texas Excellence Teaching Award given by the University of Texas Alumni Association and being named "Outstanding Core Faculty in the MBA Program" several times. He has developed several instructional guides and computerized educational programs for economics.

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Thinkwell
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We're ready to tackle the problem of consumer choice. That is, how will a household allocate its scarce income across the goods and services that provide it with satisfaction? For instance, how much of our snack budget will we spend on apples, and how much will we spend on candy bars? The answer to this problem hinges on utility theory. And it turns out that the rule the household uses to allocate its income across competing uses is this one: The household will continue to shift its money between spending on apples and spending on candy bars, until the marginal utility for extra dollars spent is equal across the two goods.
Let me give a simple example to show how this principle works. Suppose we're going shopping and we have a limited budget - say $6.00 - to spend on apples and candy. How much will we spend on each? How many candy bars will we buy, and how many apples? Suppose we start putting candy bars into our shopping basket. It cost $1.00 to buy a candy bar, and the first candy bar that we put into our shopping basket gives us a psychic satisfaction of 10 utils. So right now we're getting 10 utils per dollar from our purchase of chocolate. Suppose we also put an apple into our shopping basket, and the first apple that goes in provides us with psychic satisfaction of 8 utils. Now since apples only cost $.50, these 8 utils average out to 16 utils per dollar. That is, at the moment, we're getting more marginal utility per dollar spent on apples than we are on chocolate.
So let's go ahead and put another apple into our shopping basket, since they're such a good deal at providing us with satisfaction. The second apple also costs $.50 and it provides us with a little bit less psychic satisfaction than before - only 6 utils. Well, 6 utils for $.50 comes out to 12 utils per dollar, which is still more than we're getting from chocolate, so we'll go ahead and buy another apple. This third apple provides us with an extra utility of only 3 utils. So, 3 utils for $.50 amounts to 6 utils per dollar. Now chocolate looks like a better deal, so let's go ahead and buy another candy bar. For $1.00 spent, this next candy bar provides us with psychic satisfaction of 8 utils; 8 utils per dollar is better than 6 utils per dollar, so chocolate still looks like the best buy. Keep spending on chocolate.
Here we spend another dollar, and the third chocolate bar provides us with a marginal utility of 5. So now we're getting 5 utils per dollar from chocolate, 6 utils per dollar from apples; that means apples are looking good again. Let's put another apple into our basket. And this apple is going to give us a psychic satisfaction of 1 util; 1 util for $.50 spent is 2 utils per dollar, so now chocolate is now the preferred way of spending our snack money once again. Spend another dollar on a candy bar, and that gives us a psychic satisfaction of 2 utils; 2 utils per dollar on chocolate is equal to 1 over $.50, or 2 utils per dollar on apples.
So now at the margin an extra dollar spent on either snack is providing us with the same amount of satisfaction. Over here we'd get 2 utils from spending $1.00 on apples, and over here we'd get 2 utils from spending $1.00 on chocolate. Good thing that we equilibrated the two, because now we're out of money. That is, the consumer is going to keep shifting money between the two until marginal utility divided by price is equal for the two goods. There's no reason for us to do without an apple so we can have more chocolate, because then apples would be providing more satisfaction than chocolate at the margin; we'd want to go right back to what we were doing before. And there's no reason for us to do without a candy bar to have an extra apple, because the candy bar we'd be giving up is providing us with more satisfaction per dollar spent than an extra apple would.
If we add up the money spent - $.50, $.50, $.50, and $.50, plus $1.00, $1.00, $1.00, $1.00 - we've now spent our entire snack budget of $6.00, and we've allocated it across apples and across chocolate in such a way that the marginal utility for an extra apple divided by the price is equal to the marginal utility of an extra chocolate bar divided by the price. We spent our limited income, and we spent it across two goods in such a way that an extra dollar spent provides us with the same extra satisfaction, whether we're buying apples or chocolate. This is the rule that households use to maximize satisfaction from a limited amount of income.
Consumer Choice and Household Behavior
Utility Theory
Finding Consumer Equilibrium Page [1 of 1]

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