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Chapter 5Chapter 5Chapter 5Chapter 5Marginal Utility & Marginal Utility & Consumer ChoiceConsumer Choice

04/18/23

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What is Utility?What is Utility?

The satisfaction or enjoyment a person obtains from consuming a good

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What is a Util?What is a Util?

A hypothetical unit used to measure how much utility a person obtains from consuming a good

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What isMarginal Utility?

What isMarginal Utility?

The change in total utility a person derives from consuming an additional unit of a good

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What is Total Utility?What is Total Utility?

The total number of utils a person derives from consuming a specific quantity of a good

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TU and MUTU and MUQ TU MU0 01 10 102 18 83 24 64 28 45 30 26 30 07 28 -2

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What is the Law of Diminishing Marginal

Utility?

What is the Law of Diminishing Marginal

Utility?As more of a good is

consumed, at some point, the marginal utility a person derives from each additional unit diminishes

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Does the Law of Diminishing Marginal

Utility apply to all goods consumed?

Does the Law of Diminishing Marginal

Utility apply to all goods consumed?

YES©©1999 South-Western College Publishing

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Tot

al U

tility

Quantity

TU

1010

Mar

gina

l Util

ity

MU

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Demand CurveDemand Curve

D

P1

Q1

P2

Q211

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Why does MU = P

explain the downward sloping demand curve?

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If you are hungry for a If you are hungry for a Shawarma, how many Shawarma, how many

Shawarmas will you buy?Shawarmas will you buy?

Up to where your MU = P

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Why?Why?Because if MU > P you will buy another ShawarmaShawarma

If MU < P you will not buy that last ShawarmaShawarma

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P1

P2

Q1 Q215©©1999 South-Western College Publishing

MU

At P1, consume to Q1, since MU > P up to that point, at P2, consume to Q2, etc.

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Consumer equilibriumConsumer equilibrium

Now go from 1 good to 2 or more goods: have to take prices of good into account

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Consumer equilibrium condition

Consumer equilibrium condition

Purchase X and Y in amounts such that

MU x = MU y P x P y

Why?

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Assume you are not in equilibrium… say thatAssume you are not in equilibrium… say that

MU x > MU y P x P y

What would you do??

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Purchase more of X (due to its greater satisfaction per dollar),

and less of Y

Purchase more of X (due to its greater satisfaction per dollar),

and less of YBut more of X reduces

MUX and less of Y increases MUY so we are

heading back to equilibrium!!

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For more than 2 goods, the equilibrium condition

becomes…..

For more than 2 goods, the equilibrium condition

becomes…..MUx/Px = Muy/Py =Muz/Pz = …….for all

goods

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In other words, when is your Total Utility maximized?

When the last dollar spent on each good yields the same marginal utility

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Applications of UtilityApplications of Utility

• The water-diamond paradox--why is water so cheap and diamonds so expensive?

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Water-high TU but low MU due to abundance, diamonds the opposite-Price reflects marginal

valuation, not totals

Water-high TU but low MU due to abundance, diamonds the opposite-Price reflects marginal

valuation, not totals

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What statement do these sites make about the marginal

utility of diamonds?

What statement do these sites make about the marginal

utility of diamonds?

http://www.rostar.comhttp://www.usdiamond.com

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The marginal utility of money?

The marginal utility of money?

•Does it diminish as with goods?

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Diminishing MU of money often used as an

argument for progressive taxation.

Diminishing MU of money often used as an

argument for progressive taxation.

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What is Interpersonal comparison of utility?What is Interpersonal comparison of utility?A comparison of the

marginal utility that different people derive from a good or a dollar

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Economists argue that we should avoid such interpersonal utility

comparisons

Economists argue that we should avoid such interpersonal utility

comparisons

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What is What is Consumer Surplus?Consumer Surplus?

The difference between the maximum amount that a consumer is willing to pay for something and what he actually pays

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P

Q

Consumer Surplus

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What happens to Consumer Surplus as

Market Price changes?

What happens to Consumer Surplus as

Market Price changes? It increases when price

falls and falls when prices increase

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• What is a Util?• What is Utility?• What is Marginal Utility?• What is Total Utility?• What is the Law of Diminishing

Marginal Utility?• What is a Demand Curve?