(7) Consumer Choice and Production

Total Video Time: 99 minutes



You’ve already learned about supply and demand, and put them together to analyze markets. Now we’re going to examine more closely the decision-making behavior by consumers and firms that leads to the demand and supply curves. We’ll start with consumer choice — why do people make the decisions they make? Seems straightforward enough, but we’ll try to formalize it a little and then use it to understand why the demand curve is downward-sloping. Then we’ll move on to firm behavior, which is a little more solid mathematically than the consumer choice stuff (because firms are evaluating costs and benefits that are measured in dollars, while consumer choices are a little different).

Video 7.1: Utility Maximization (13 min)
This video examines the concept of utility maximization and proposes a general rule consumers should follow to maximize their utility: the Marginal Utility (MU) per dollar for the last unit of each good consumed should be equal.

Video 7.2: Utility and Demand (11 min)
This video uses the Marginal Utility framework developed in the previous video to show how we can derive a demand curve for a good. It also explains the link between the shape of the MU curve for a good and the elasticity of the demand for the good.

Video 7.3: Price Ceilings Revisited (12 min)
This video incorporates the knowledge we gained in Module 6 about elasticity and the concept of consumer surplus to re-examine price ceilings to discover when consumers as a whole will be better off as a result of price ceilings, and when they might be worse off.

Video 6.4 looked at the importance of the supply elasticity in determining the effects of a price ceiling: when price falls, the impact on the market depends on how much firms reduce their output. Similarly, when the government imposes a price floor, the impact on the market depends on how much consumers reduce their purchases of the good; that is, it depends on the demand elasticity.

If the good has inelastic demand, consumers can’t really substitute away from the product so quantity drops only slightly. And since firms are getting a higher price for all of those units, producers will be happy. But if the good has elastic supply, consumers have lots of other options and will substitute away from the product easily. In that case, the quantity sold in the market will drop substantially, possibly so much that firms are actually worse off. Yes, they’re getting a higher price for their output, but they’re selling so few units of output at the high price that the price floor (which was designed to help producers) actually makes them worse off.
An example of this is when minimum wages are imposed on industries whose demand for labor is elastic. Increasing the wage firms must pay just causes them to outsource the work to other countries or replace their workers with machines. Thus, the policy designed to help workers ends up causing many of them to lose their jobs.


A little dose of reality is in order here: this topic is often the most boring and most difficult for students. I can usually make the course material interesting by using examples you can understand and relate to, but even I have difficulty making this topic interesting and I have no problem admitting that. However, it is important to have a good understanding of costs and productivity because they establish the behavior of firms. The next three modules on market structure start with an assumption of firms’ costs and then apply different competitive environments to see how a firm’s output and pricing decisions depend on their competitive environment. We will also compare the allocative and productive efficiency of different market structures and those both depend on firms’ cost curves. Thus, it’s extremely important that you understand where these cost curves come from and why they look the way they do.

So as difficult as it might be to pay attention in this module, I implore you to not get frustrated but to double up your efforts and ask questions if there is anything you don’t understand. If you don’t have a good grasp on this material, the next few modules will be much harder for you.

Video 7.4: Profit (11 min)

This video examines the differences between accounting profit and economic profit.


Video 7.5: Productivity (11 min)

This video explains the production function for a simple firm: it produces with capital and labor. It explains short-run productivity of labor and explains why the Marginal Product of Labor (MPL) typically behaves.


Video 7.6: Cost Curves (9 min)

This video goes through the three main cost curves (MC, ATC and AVC) and explains why they are important: they answer three different questions for a firm. By better understanding how we will use these curves, it will be easier to understand our discussion of how each of them look for a typical firm.


Video 7.7: Marginal Cost (10 min)

This video uses a simple example to explain the inverse relationship between marginal cost (MC), marginal product of labor (MPL), and explains what we think the MC curve typically looks like.


Video 7.8: Average Costs (12 min)

This video explains what the Average Total Cost (ATC), Average Fixed Cost (AFC) and Average Variable Cost (AVC) curves look like and why.


Video 7.9: Changes in Costs (10 min)

This video explores what happens when there is an increase in fixed costs vs. an increase in variable costs. It shows how the graphs change and how we might expect the firms to respond to them.


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