Consumer Optimization Marginal Revolution University English (auto-generated) English

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Education 55.2K views 684 likes 12 dislikes 20 Jun 2017

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♪ [music] ♪

the way we make choices about what to

[Joana] The way we make choices about what to buy

buy depends on how our dreams are want meet reality we've covered thinking on

depends on how our dreams, our wants, meet reality.

the margin budget constraints and

We've covered thinking on the margin,

indifference curves now let's bring this

budget constraints, and indifference curves.

all together to model how you decide what to purchase remember your budget

Now let's bring this all together to model how you decide what to purchase.

constraint represents how the market

Remember, your budget constraint represents

values goods and what you can afford

how the market values goods

given your income your indifference

and what you can afford, given your income.

curves represent how you value goods

Your indifference curves represent how you value goods

based on your personal preferences we

based on your personal preferences.

all wish we could have more of

We all wish we could have more of everything.

everything we would love to be way out

We would love to be way out here

here where we can consume as much as we

where we can consume as much as we want.

want but the reality is that we have

But the reality is that we have limited resources

limited resources and the prices of things force us to make trade-offs we

and the prices of things force us to make tradeoffs.

want to get the best bang for our buck

We want to get the best bang for our buck

and that means finding that optimal combination of goods that brings

and that means finding that optimal combination of goods

together how the market values goods and

that brings together how the market values goods

our preferences that's what this graph

and our preferences.

illustrating your indifference curves

That's what this graph, illustrating your indifference curves

and budget constraint lets us better

and budget constraint, lets us better understand.

understand when you make a decision you

When you make a decision,

are effectively trying to be the happiest that you can given the

you are effectively trying to be the happiest that you can,

constraints and you face you are without

given the constraints that you face.

knowing solving a constrained

You are, without knowing, solving

optimization problem where you are

a "constrained optimization" problem, where you are choosing

choosing the combination of goods that maximize your utility given the prices

the combination of goods that maximize your utility

of goods and your income let's go back

given the prices of goods and your income.

to our pizza and coffee example you have

Let's go back to our pizza and coffee example.

a budget of $50 Pizza costs $10 in each

You have a budget of $50. Pizza costs $10.

cup of coffee costs $5 now let's assume

And each cup of coffee costs $5.

your indifference map looks like this

Now, let's assume your indifference map looks like this.

making the best choice you can afford

Making the best choice you can afford means

means you will spend your entire budget

you will spend your entire budget

on the combination of pizzas and cups of

on the combination of pizzas and cups of coffee

coffee that make you the happiest this

that make you the happiest.

means that your optimal consumption

This means that your optimal consumption combination

combination is on your budget line

is on your budget line.

making the best choice you can afford

Making the best choice you can afford also means

also means that you will try to reach

that you will try to reach the indifference curve

the indifference curve that represents the highest degree of satisfaction or utility because pizza and coffee are

that represents the highest degree of satisfaction or utility. Because pizza and coffee are good things --

good things things that make you happy

things that make you happy --

this will occur on the indifference

this will occur on the indifference curve

curve that is the farthest away from the origin why because the more pizza and

that is the farthest away from the origin. Why?

coffee you have the happier you are what

Because the more pizza and coffee you have, the happier you are.

keeps you from reaching this indifference curve if you thought prices

What keeps you from reaching this indifference curve?

and income you are right your budget

If you thought prices and income, you are right!

constraint determines what you can

Your budget constraint determines what you can afford.

afford so your optimal consumption combination will be where your budget

So your optimal consumption combination will be

constraint is tangent to the highest

where your budget constraint is tangent

indifference curve to see why let's go back to thinking about why you try to

to the highest indifference curve. To see why, let's go back to thinking about

reach the indifference curve that is the

why you try to reach the indifference curve

farthest away from the origin the best

that is the farthest away from the origin.

way to go about it is to look at a point

The best way to go about it is to look at a point

where the budget line intersects one of your indifference curves this particular

where the budget line intersects one of your indifference curves.

combination of pizza and coffee it's

This particular combination of pizza and coffee --

affordable because it's on your budget

it's affordable, because it's on your budget line.

line however you are not the happiest you could be now are you given your

However, you are not the happiest you could be, now are you?

preferences it's clear that you would be

Given your preferences, it's clear that you would be happier

happier if you provide this combination

if you could buy this combination.

it has more pizza and just so many cups

It has more pizza,

of coffee but hey it's beyond your

and just as many cups of coffee.

budget but now look at this you are

But, hey, it's beyond your budget. But now look at this.

indifferent between this combination in

You are indifferent between this combination

this combination both are on the same

and this combination.

indifference curve and that means they

Both are on the same indifference curve,

provide you with the same utility so if

and that means they provide you with the same utility.

you are trying to get the most utility

So, if you are trying to get the most utility you can,

you can given what you can afford

given what you can afford,

you will never choose a combination of

you will never choose a combination of goods

goods that intersect

that intersects your budget constraint.

a budget constraint you will choose one that is tangent to it the point of

You will choose one that is tangent to it.

tangency between the budget constraint

The point of tangency between the budget constraint

and the indifference curve also means

and the indifference curve also means

that at your optimal consumption

that at your optimal consumption combination,

combination the markets relative price of the goods equal your willingness to

the market's relative price of the goods equals

substitute between them and that's your

your willingness to substitute between them --

marginal rate of substitution another

and that's your marginal rate of substitution.

way to see this is to recognize that

Another way to see this is to recognize

it's your best choice the marginal

that at your best choice,

utility per dollar both goods is the

the marginal utility per dollar of both goods is the same.

same let's go back to thinking at the

Let's go back to thinking at the margin.

margin at this point would it make you

At this point, would it make you happier

happier to spend more money on pizza and less on coffee here the marginal rate of substitution is 4 and that means you are

to spend more money on pizza and less on coffee? Here, the marginal rate of substitution is 4,

willing to forego 4 cups of coffee to

and that means you are willing to forego four cups of coffee

get one additional pizza but pizza is

to get one additional pizza.

only twice as expensive as coffee so

But pizza is only twice as expensive as coffee.

this is great news for you the market is

So this is great news for you.

asking you to forego fewer cups of

The market is asking you to forego fewer cups of coffee

coffees and you are willing to so you

than you are willing to.

get that extra Pizza another way to

So you get that extra pizza.

think about this is to realize that at

Another way to think about this is to realize that at this point,

this point your marginal utility per dollar speech that is greater and your

your marginal utility per dollar of pizza is greater

marginal utility per dollar from cups of

than your marginal utility per dollar from cups of coffee.

coffee remember if you get more pizzas

Remember, as you get more pizzas,

and are left with fewer cups of coffee

and are left with fewer cups of coffee,

your marginal utility from pieces is

your marginal utility from pizzas is decreasing,

decreasing in term our gional utility from cups of coffee is increasing you

and your marginal utility from cups of coffee is increasing.

will stop getting additional pizzas when

You will stop getting additional pizzas

your marginal utility for dollars from

when your marginal utility per dollar

both Goods is equal

from both goods is equal.

of course very few of us calculate marginal utility or think of constrained

Of course, very few of us calculate marginal utility

optimization when we choose what to buy

or think of constrained optimization

but these concepts can help you

when we choose what to buy. But these concepts can help you understand your world

understand your world and guide you how to make better decisions in the future

and guide you how to make better decisions in the future.

you're on your way to mastering

[Narrator] You're on your way to mastering economics.

economics make sure this video is fixed

Make sure this video sticks

by taking a few quick practice questions

by taking a few quick practice questions.

or if you're ready for more

Or, if you're ready for more microeconomics,

microeconomics click for the next video still here

click for the next video.

check out marginal revolution University other popular videos

Still here? Check out Marginal Revolution University's other popular videos. ♪ [music] ♪

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