Micro. Fall 2022. Key Terms. Chapter 8

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Econ 1010 (Fall 2022) - Key Terms – Chapter 8: Marginal Utility Theory
1. Consumption Choices:
a. The choices that you make as a buyer of goods and services are influenced by
many factors. However, they can be summarised in two broad categories.
i. Consumption Possibilities
ii. Preferences
2. Consumption Possibilities:
a. Your consumptions possibilities are all the things that you can afford to buy.
b. You can afford many different combinations of goods and services, however,
there are limitations:
i. Your Income
ii. The Prices of the Goods
3. Consumption Model:
a. Establish a Economic Model:
i. Limited Consumer Income
ii. Limit the Consumer to buying “2” Goods:
1. Movies
2. Cola
iii. Limit the Consumer by the Prices of these “2” Goods
1. Price of Movies
2. Price of Cola
b. Create a Budget Line:

i. When a consumer spends all her income, she reaches the limits to her
consumption possibilities, we call that limit a budget line.
ii. Budget Line:

1. Is a boundary that the marks those combinations of goods and
services that a household can afford to buy and those that it cannot
afford to buy.
2. Graph:
i. Affordable: On or Inside the Budget Line
ii. Unaffordable: Outside the Budget Line
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3.
4. Equations: (Note: Cola is plotted on the Vertical Axis.)
I ncome={Expenditure on Good C+ Expenditure on Good M }
M ={ ( P C∗Q C )+(P M∗Q M )}
Rewrite the Budget Equation into a Linear Line Equation to find the Following:
L inear Line Equation:Q C= ( PMC )−( PP MC )Q M

(M )
Where, Vertical Intercept= P C H orizontal Intercept= ( PMM )
( Rise
S lope of the Budget Line =
Run )=(
PC )
PM
I ncome=Y ; Price of Cola=PC Price of Movies=P M Quantity :Q C∧Q M

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iii. Changes in Consumption Possibilities:
1. 3 Causes of Shifts or Rotations in the Budget Line:

a. Δ M −Change∈Income
b. ΔP of the Good on the Horizontal Axis
c. ΔP of the Good on the Vertical Axis
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4. Preferences:
i. The consumer’s choice depends upon their preferences.
1. Preferences are the consumers “Likes & Dislikes”.
2. Economists can describe “preferences” using MB (Chapter 2)
3. Or a deeper approach is using the “Idea of Utility”.
ii. Utility:
1. Is the benefit or satisfaction that a person gets form consumption
of goods and services.
a. “Util” is the unit of measurement of Utility.
2. Total Utility (TU):

a. Is the total benefit that a person gets from the consumption
of all the different goods and services.
b. TU depends on the level of consumption – more consumption
generally gives more total utility.
3. Marginal Utility (MU):
a. Is the change in total utility that results from a one-unit

increase in the quantity of a good consumed.
MU= ( ΔTU
ΔQ )
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b. MU numbers appear midway between the quantities of cola

because it is the change in the quantity, she buys from 1 to 2
and 2 to 3 that produces the MU.
c. MU is positive, but is diminishing as the quantity of a good,

consumed increases.
I. The things that people enjoy and want more
of have a positive MU.
II. However, some objects or actives can
generate negative MU and lower total utility,
ex. hard labour & polluted air.
d. The Principle of Diminishing Marginal Utility:

i. Is the tendency for MU to decrease as the consumption
of good increase is so general and universal that is a
Principle in Economics.
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5. Utility-Maximizing Choice:
a. Consumers want to get the most utility possible form their limited resources.
So, lets put the two stories together.
b. A Spreadsheet Solution:
i. Find the Just-Affordable Combination

ii. Find the TU for Each Just-Affordable Combination
iii. NOTE: Table 8.1 on page 185 of the 11th Edition of the Textbook.
iv. Consumer Equilibrium:
1. Is a situation in which a consumer has allocated all their available
income in the way that maximizes their
TU, given the prices of the goods and services.
2. Example in Table 8.1: Answer: 2 Movies & 6 Cola
3. Consumer Equilibrium=Maximizes TU
c. Choosing at the Margin:
i. Economists interpret your best possible choice by using the idea of

Marginal Utility per Dollar.
1. Marginal Utility:
a. is the increase in total utility that results from consuming
one more unit of the good.
(
ΔTU
b. M U = ΔQ )
2. Marginal Utility per Dollar:
a. In the marginal utility from a good that results from spending
one more dollar on that good.
( MU M
3. Marginal Utiltiy per dollar ¿ movies= P M )
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MU C
4. Marginal Utility per dollar ¿ cola=( PC )
d. Utility-Maximizing RULE:
i. A Consumer’s TU is maximized by the following rule:
1. Spend ALL the available income.

a. M ={ ( P C∗Q C )+(P M∗Q M )}
2. Equalize the Marginal Utility per dollar for all goods.

a. ( MUP MM )=( MUP CC )
ii. Utility-Maximizing Movies & Cola:

1. Example: From the Textbook: Figure & Table on p. 187
iii. Achieving Equilibrium: (NOTE: Additional Graphs shown in Class.)
( )
MU M MU C
a. Case ¿ 1: P M <( P C )
b. Case ¿ 2 :( P M )>( P C )
MU M MU C
iv.
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6. Predications of Marginal Utility Theory:

a. MU Theory can be used to predict:
i. Law of Demand
ii. Shift of Demand Curve resulting from:
1. Change in the Price of Another Good
2. Change in Income
b. To derive these predications, the following “3” Events would be solved:
i. Case ¿ 1: ↓ P Movies:
1. Re-Solve Best Affordable Combinations: p. 189
a. Movement Along the Demand Curve for Movies:
b. Shift of the Demand Curve for Cola
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ii. Case ¿ 2 :↑ P Cola :

a. Movement Along the Demand Curve for Cola: p. 191
iii. Case ¿ 3 :↑ M :
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a. Shift of the Demand Curve for Movies: p. 192
b. Shift of the Demand Curve for Cola: p. 192
7. Paradox of Value:
a. The price of water is low, the price of a diamond is high, but water is essential
to life while diamonds are used mostly for decoration. How can valuable water
be so cheap while relatively useless diamond be so expensive?
i. This is the Paradox of Value.
b. The paradox is resolved by distinguishing between TU & MU:
i. TU of water is huge; however we consume a tremendous amount of
water resulting in the MU of water to be very small.
ii. TU of water is very small; however, we only consume very few
diamonds resulting in the MU of diamonds to be very large.
c. Diamond Water Paradox:
i. Equilibruim : ( MUP DD )=( MUP WW )
ii. where , D=Diamonds∧W =Water
d. Value & Consumer Surplus:

i. Another way to understand paradox of value is to consider the
Consumer Surplus for water compared to diamonds.
ii. “Water is cheap but brings a large consumer surplus; diamonds are
expensive, but bring a small consumer surplus.”
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END Chapter 8 – PAGE 193

Note: All Multiple-Choice Questions from pages 194 to the end of the chapter have been
removed from the Testbank.

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Page 1 of 11

b. Create a Budget Line:

ii. Budget Line:

4. Equations: (Note: Cola is plotted on the Vertical Axis.)

I ncome={Expenditure on Good C+ Expenditure on Good M }

M ={ ( P C∗Q C )+(P M∗Q M )}

L inear Line Equation:Q C= ( PMC )−( PP MC )Q M

I ncome=Y ; Price of Cola=PC Price of Movies=P M Quantity :Q C∧Q M

iii. Changes in Consumption Possibilities:

1. 3 Causes of Shifts or Rotations in the Budget Line:

2. Total Utility (TU):

3. Marginal Utility (MU):

a. Is the change in total utility that results from a one-unit

b. MU numbers appear midway between the quantities of cola

c. MU is positive, but is diminishing as the quantity of a good,

d. The Principle of Diminishing Marginal Utility:

i. Find the Just-Affordable Combination

c. Choosing at the Margin:

i. Economists interpret your best possible choice by using the idea of

1. Spend ALL the available income.

2. Equalize the Marginal Utility per dollar for all goods.

ii. Utility-Maximizing Movies & Cola:

iii. Achieving Equilibrium: (NOTE: Additional Graphs shown in Class.)

6. Predications of Marginal Utility Theory:

b. To derive these predications, the following “3” Events would be solved:

ii. Case ¿ 2 :↑ P Cola :

1. Re-Solve Best Affordable Combinations: p. 192

d. Value & Consumer Surplus:

END Chapter 8 – PAGE 193

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