Download In Utils

Consumer Choice and
Utility Maximization
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The Law of Diminishing “ADDITIONAL”
“SATISFACTION”
2
DEFINITIONS
• Law of Diminishing Marginal utility:
Added satisfaction declines as a consumer
acquires additional units of a given product.
• Utility = a measure of want satisfying
power. Utility is personal and subjective.
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DEFINITIONS
• Total Utility: The total amount of
satisfaction or pleasure a person derives
from consuming some specific quantity of a
good or service.
• Marginal Utility: The extra satisfaction a
consumer realizes from an additional unit of
that product
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Thinking at the Margin
# Times
Watching Movie
1st
2nd
3rd
Total
Marginal
Utility
$30
$15
$5
$50
Price
$10
$10
$10
$30
Would you see the movie three times?
Notice that the total benefit is more than the
total cost but you would NOT watch the movie
the 3rd time.
Calculate Marginal Utility
# of Slices of
Pizza
0
1
2
Total Utility
(in utils)
0
8
14
3
4
5
6
7
19
23
25
26
26
8
24
Marginal
Utility/Benefit
How many pizzas would you buy if the price
per slice was $2?
6
Calculate Marginal Utility
# of Slices of
Pizza
0
1
2
Total Utility
(in dollars)
0
8
14
3
4
5
6
7
8
Marginal
Marginal Cost
Utility/Benefit
0
8
6
$2
$2
$2
19
23
25
26
26
5
4
2
1
0
$2
$2
$2
$2
$2
24
-2
$2
How many pizzas would you buy if the price
per slice was $2?
7
Calculate Marginal Utility
# of Slices of
Pizza
0
1
2
3
4
5
6
7
8
Total Utility
(in dollars)
0
8
14
Marginal
Marginal Cost
Utility/Benefit
0
8
6
You will continue to
consume
until
19
5
23
4
Marginal
Benefit
=
25
2
Marginal
Cost
26
1
26
24
0
-2
2
2
2
2
2
2
2
2
2
How many pizzas would you buy if the price
per slice was $2?
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CONSUMER BEHAVIOR
You plan to take a vacation and want to maximize
your utility. Based on the info below, which should
you choose?
Destination
Marginal Utility
(In Utils)
Price
Marginal Utility
Per Dollar
Tahiti
3000
$3,000
1 Util
Chicago
1000
$500
2 Utils
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CONSUMER BEHAVIOR
You plan to take a vacation and want to maximize
your utility. Based on the info below, which should
you choose?
Destination
Marginal Utility
(In Utils)
Price
Marginal Utility
Per Dollar
Tahiti
3000
$3,000
1 Util
Chicago
1000
$500
2 Utils
Calculating Marginal Utility Per Dollar allows
you to compare products with different prices.
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$10
Utility Maximization
# Times
Going
Marginal
Utility
(Movies)
1st
2nd
3rd
4th
30
20
10
5
MU/P
(Price =$10)
Marginal
Utility
(Go Carts)
$5
MU/P
(Price =$5)
10
5
2
1
If you only have $25, what combination of
movies and go carts maximizes your utility?
$10
Utility Maximization
# Times
Going
Marginal
Utility
(Movies)
1st
2nd
3rd
4th
30
20
10
5
$5
(Price =$10)
Marginal
Utility
(Go Carts)
(Price =$5)
3
$2
$1
$.50
10
5
2
1
$2
$1
$.40
$.20
MU/P
MU/P
If you only have $25, what combination of
movies and go carts maximizes your utility?
$10
Utility Maximization
# Times
Going
Marginal
Utility
(Movies)
1st
2nd
3rd
4th
30
20
10
5
$5
(Price =$10)
Marginal
Utility
(Go Carts)
(Price =$5)
3
$2
$1
$.50
10
5
2
1
2
$1
$.40
$.20
MU/P
MU/P
If you only have $25, what combination of
movies and go carts maximizes your utility?
$10
Utility Maximization
# Times
Going
Marginal
Utility
(Movies)
1st
2nd
3rd
4th
30
20
10
5
$5
(Price =$10)
Marginal
Utility
(Go Carts)
(Price =$5)
3
2
1
.50
10
5
2
1
2
1
.40
.20
MU/P
MU/P
If you only have $25, what combination of
movies and go carts maximizes your utility?
Utility Maximizing Rule
The consumer’s money should be spent so that the
marginal utility per dollar of each goods equal each
other.
MUx = MUy
Px
Py
Assume apples cost $1 each and oranges cost $2 each. If the
consumer has $7, identify the combination that maximizes utility. 15
Utility Maximizing Rule
The utility maximizing rule assumes that you always
consume where MU/P for each product is equal
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Utility Maximizing Rule
The utility maximizing rule assumes that you always
consume where MU/P for each product is equal
b) Assume that the cross-price elasticity of demand between
peanuts and bananas is positive. A widespread disease has
destroyed the banana crop. What will happen to the equilibrium
price and quantity of peanuts in the short run? Explain.
(a)Equilibrium price and quantity will both increase. Peanuts and
bananas are substitutes (they have a positive cross-elasticity), so
an increase in the price of bananas will cause demand for
peanuts to increase.
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Utility Maximizing Rule
The utility maximizing rule assumes that you always
consume where MU/P for each product is equal
c) Assume that the price of bananas increases.
(i) Will the substitution effect increase, decrease, or have no
effect on the quantity of bananas demanded?
(ii) What happens to Sasha's real income?
i) Decrease
ii)Decrease
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