A Simple Plan to Teach Consumer Choice

Learning Objectives:

  1. Students will demonstrate the ability to identify the optimal consumer choice given a budget constraint.
  2. Students will identify situations where non-optimal bundles are acquired.

Warm Up:

Ask students what they think is the best phone. If they didn’t get that phone have the group explain why they didn’t buy it. Note that simply not having enough money or it was too expensive is not an acceptable answer. They need to explain what they gain by buying the cheaper phone.

Direct Instruction:

In the video, the band lists a number of items that they want without regard to their opportunity cost.  When purchasing a good you have to consider both the happiness the good will provide you and the happiness the alternative will provide you.  The reason you purchased the less expensive phone is you value the goods that you could purchase with the additional cash more than the increase in phone quality. 

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Discuss the idea of a consumption bundle.  Give the example that the phone is in a consumption bundle with all other goods.  Each of these bundles have a set amount of utility and some of them have the same amount of utility but different amounts of the good.  We recommend that the instructor follow the approach in Holmgren (2017) to teach this lesson as it doesn’t require advanced mathematics.

In the end, the consumption bundle can be simplified to two goods: the phone good (which can be thought of as phone quality), and a combined good representing all other goods.

The consumer chooses the point where the indifference curve just touches the budget constraint.  The higher indifference curve is unavailable due to the budget constraint and the lower indifference curve provides less total utility.

Guided Practice:

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Bring this concept back to the phone.  Suppose that the consumer values phone quality at q^(3/4) (where q is phone quality) and all other goods at o^(1/4) (total utility equals: q^(3/4)+ o^(1/4)).  For simplicity assume that the price of phone quality and other goods is $1.  Have your students consider the following bundles (you can have them fill-in the utility columns for practice). 

If the consumer’s budget is 10, they will end up purchasing bundle 10.  If the consumer’s budget is 20, they will purchase bundle 21.  Both bundles contain a mix of both phone quality and other goods.  This is despite a utility function, that on the surface, values phone quality above other goods.  

Cool Down:

Relating this back to the song, explain to the students that it is perfectly possible to receive a good as a gift that you enjoy, but would not otherwise be something that you purchase.  Consider the below figure.  

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A gift represents a possible wealth transfer of the value of the gift -- this is the movement of the budget constraint.  However, when the good is a gift, the bundle is predetermined.  This is represented by the red dot.  If you received the gift as cash, you would actually purchase the blue dot.  Notably, you would buy less of the gift good and more other goods if you had a choice.  This means you are less happy than you could be given the same amount of total spending.

Waldfogel (1993) shows that this process of gift giving actually produces a deadweight loss for society (this analysis ignores the utility generated by giving or receiving a gift from a loved one).  When only considering the utility from the product itself, the degree to which gift giving creates a deadweight loss is dependent on how well the gift giver matches your preferences.  In other words, how close the gifted bundle (red dot) matches the bundle you purchase with your own money (blue dot).

References:

Holmgren, M. (2017). From continuous to discrete: An alternative approach to teaching consumer choice. Journal of Economics Teaching, 2(1), 1-13. http://downloads.journalofeconomicsteaching.org/2/1/1-1.pdf 

Waldfogel, J. (1993). The deadweight loss of Christmas. The American Economic Review. http://doi.org/10.2307/2117564