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Chapter 7
Utility
Maximization
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Law of Diminishing Marginal
Utility
• Law of diminishing marginal utility
• As consumption of a good or service
increases, the marginal utility obtained
from each additional unit of a good or
service decreases
• Explains downward sloping demand curve
LO1
7-2
Terminology
• Utility is the satisfaction one gets from
consuming a good or service
• Not the same as usefulness
• Subjective
• Difficult to quantify
LO1
7-3
Total Utility and Marginal Utility
• Util is one unit of satisfaction or pleasure
• Total utility is the total amount of satisfaction
• Marginal utility is the extra satisfaction from
an additional unit of the good
• MU = ΔTU/ΔQ
LO1
7-4
Total Utility and Marginal Utility
Total Utility
4
5
6
7
LO1
0
]
10
]
18
]
24
]
28
]
30
]
30
]
28
(3)
Marginal
Utility,
Utils
10
8
30
Total utility (utils)
0
1
2
3
(2)
Total
Utility,
Utils
4
2
0
-2
TU
20
10
0
6
Marginal utility (utils)
(1)
Tacos
Consumed
Per Meal
1
2
3
4
5
6
7
1
2
3
4
5
6
7 MU
10
8
6
4
2
0
-2
7-5
Theory of Consumer Behavior
•
•
•
•
LO2
Rational behavior
Preferences
Budget constraint
Prices
7-6
Utility Maximizing Rule
• Consumer equilibrium
• Consumer allocates his or her income so that
the last dollar spent on each product yields
the same amount of extra (marginal) utility
• Algebraically,
MU of product A
Price of A
LO2
=
MU of product B
Price of B
7-7
Numerical Example
The Utility Maximizing Combination of Apples and Oranges Obtainable with an Income of $10
(1)
Unit of Product
(2)
Apple (Product A):
Price = $1
(3)
Oranges (Product B):
Price = $2
(b)
(a)
Marginal Utility
Marginal Utility,
per dollar
Utils
(MU/Price)
(b)
(a)
Marginal Utility
Marginal Utility,
per dollar
Utils
(MU/Price)
First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Fourth
6
6
16
8
Fifth
5
5
12
6
Sixth
4
4
6
3
Seventh
3
3
4
2
7-8
LO2
Decision-Making Process
Sequence of Purchases to Achieve Consumer Equilibrium
Choice
Number
Potential Choices
Marginal
Utility
per Dollar
Purchase Decision
Income
Remaining
1
First Apple
First Orange
10
12
First orange for $2
$8 = $10 - $2
2
First Apple
Second Orange
10
10
First apple for $1
and Second orange for $2
$5 = $8 - $3
3
Second Apple
Third Orange
8
9
Third orange for $2
$3 = $5 - $2
4
Second Apple
Fourth Orange
8
8
Second apple for $1
and Fourth orange for $2
$0 = $3 - $3
7-9
LO2
Deriving the Demand Curve
Price Per
Orange
Quantity
Demanded
$2
4
1
6
Price per orange
$2
$1
DO
0
LO3
4
6
Quantity demanded of oranges
7-10
Income and Substitution Effects
• Income effect
• The impact a price change has on a
consumer’s real income
• Substitution effect
• The impact a price change on a product’s
relative expensiveness
LO4
7-11
Applications and Extensions
•
•
•
•
•
•
LO5
New products
iPad
Diamond-water paradox
Opportunity cost and time
Medical care purchases
Cash and noncash gifts
7-12
Criminal Behavior
• The criminal attempts to maximize his or her
total utility
• Compares the marginal benefit with the
marginal cost of the unlawful activity
• Most people find the costs too high
• For others, society imposes additional costs
such as fines and imprisonment
• Potential to reduce crime by increasing the
cost of crime
7-13