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PARKIN
BADE
ECONOMICS
Chapter 7
Utility and Demand
Household Consumption Choices
 Household consumption choices determined by

budget constraint



income and prices (P) of goods
and services given
budget line — boundary between
affordable and unaffordable prices
preferences — likes and dislikes
Figure 7.1
Consumption Possibilities
Pop 10
a
b
8
Unaffordable
c
6
d
4
Affordable
e
2
f
0
1
2
Copyright © 1997 Addison-Wesley Publishers Ltd.
3
4
5
6
7
8
9 10
Movies
Textbook p. 149
Utility
 Total Utility (TU)

total benefit or satisfaction from
consumption

consumption  TU
continued
Figure 7.2a
Total Utility
Utility
200
TU
150
100
50
0
1
2
Copyright © 1997 Addison-Wesley Publishers Ltd.
3
4
5
Q
Textbook p. 151
Utility
 Marginal Utility (MU)

D TU from one-unit quantity consumed

diminishing marginal utility —
MU positive, but  as consumption
Figure 7.2b
Marginal Utility
Utility
50
MU
50
0
38
1
33
2
29
3
25
4
5
Q
Copyright © 1997 Addison-Wesley Publishers Ltd.
Textbook p. 151
Figure 7.2
Total Utility and Marginal Utility
Utility
200
TU
150
Utility
…and diminishing
marginal utility
Increasing
total
utility
100
50
50
MU
50
0
1
2
3
4
5
(a) Total utility
Copyright © 1997 Addison-Wesley Publishers Ltd.
Q
0
38
1
33
2
29
3
25
4
5
Q
(b) Marginal utility
Textbook p. 151
Maximizing Utility
 Consumers strive for utility maximization

given income and prices, consumer
equilibrium when income allocated to
maximize TU

TU maximized when
MUm MUp
=
Pm
Pp
continued
Maximizing Utility
 If marginal gain exceeds marginal loss, take the
action

if MU / $ for movies > MU / $ for pop,
buy more movies, less pop

marginal gain from more movies > marginal
loss from less pop
Figure 7.3
Equalizing Marginal Utilities/Dollar Spent
MUp
Pp
MU 16.00
P
Maximum TU
8.33
Utility gain:
pop,  movies
6.33
5.67
Utility gain:
movies, pop
0.00
Movies
0
Pop
10
1
8
Copyright © 1997 Addison-Wesley Publishers Ltd.
2
6
MUm
Pm
3
4
4
2
5
0
Q
Textbook p. 153
Predictions of Marginal Utility Theory
 Ceteris paribus,  Pm  Qm and 
leftward shift demand curve pop
 Ceteris paribus, Pp   Qp and 
rightward shift demand curve movies
 Movies and pop normal goods

ceteris paribus, income 
rightward shifts both demand curves
continued
Predictions of Marginal Utility Theory
 Individual and market demand

individual demand

market demand

market demand curve —
horizontal sum of individual demand
curves
Figure 7.6a
Individual and Market Demand Curves:
Lisa’s Demand
P
Lisa’s demand
6
4
3
2
0
2
Copyright © 1997 Addison-Wesley Publishers Ltd.
4
5
6
Q
Textbook p. 158
Figure 7.6b
Individual and Market Demand Curves:
Chuck’s Demand
P
6
4
Chuck’s demand
3
2
0
2
Copyright © 1997 Addison-Wesley Publishers Ltd.
4
6
Q
Textbook p. 158
Figure 7.6c
Individual and Market Demand Curves:
Market Demand
P
Market demand
6
4
3
2
0
2
Copyright © 1997 Addison-Wesley Publishers Ltd.
4
6
7
8
Q
Textbook p. 158
Figure 7.6
Individual and Market Demand Curves
(a)
(b)
(c)
P
P
P
3
3
3
0
5
Lisa’s demand
Q
0
2
Q
Chuck’s demand
Copyright © 1997 Addison-Wesley Publishers Ltd.
0
7
Q
Market demand
Textbook p. 158
Criticisms of Marginal Utility Theory
 Utility can't be observed

but utility does not need to be observed to
be used
 Consumers aren't as smart as theory implies

but theory makes no predictions about real
consumers' thought processes; simply
predicts real consumers' actions
Implications of Marginal Utility Theory
 Consumer surplus

value of good —
maximum willing to pay for it

consumer surplus —
value minus price

consumer surplus —
area under demand curve,
but above market price
continued
Figure 7.7a
P
Consumer Surplus: Individual
8
Maximum prices
willing to pay for
1, 2, 3, and 4 movies
7
6
5
Market
price
4
3
2
1
0
Consumer
surplus
1
2
Copyright © 1997 Addison-Wesley Publishers Ltd.
3
D
4
5
6
7
8
Q
Textbook p. 161
Figure 7.7b
P
Consumer Surplus: Market
8
7
6
5
Market
price
4
3
2
1
0
Consumer
surplus
1
2
3
D
4
5
6
7
8
Q
Copyright © 1997 Addison-Wesley Publishers Ltd.
Textbook p. 161
Implications of Marginal Utility Theory
 Distinction between TU and MU resolves
diamond-water paradox

diamonds, less useful (low TU),
but higher price (high MU)

water more useful (high TU),
but lower price (low MU)
End of Chapter