Utility and Demand

Consumer Theory • Preferences

– A household’s preferences determine the benefits
or satisfaction a person receives consuming a
good or service.
– The benefit or satisfaction from consuming a good

Topic 3 or service is called utility.

• Total Utility
– Total utility is the total benefit a person gets from
the consumption of goods. Generally, more
consumption gives more utility.

Maximizing Total Utility Maximizing Utility

3.1
– Table 3.1 provides an • Marginal Utility
example of total utility
schedule. – Marginal utility is the change in total utility that
– Total utility from a results from a one-unit increase in the quantity of
good increases as the a good consumed.
quantity of the good
– As the quantity consumed of a good increases, the
increases.
marginal utility from consuming it decreases.
– For example, as the
number of movies – We call this decrease in marginal utility as the
seen in a month quantity of the good consumed increases the
increases, total utility principle(Law) of diminishing marginal utility.
from movies increases.
 Maximizing Total Utility Maximizing Total Utility
3.1 TU of soda increases at a
– Table 3.1 provides an – Figure 3.1(a) shows decreasing rate.
example of total utility a total utility curve
schedule.
for soda.
– Total utility from a
good increases as the – Total utility(TU)
quantity of the good increases with the
increases. consumption of a
– For example, as the soda increases.
number of movies
seen in a month – (positive relationship)
increases, total utility – Upward sloping
from movies increases.
– TU increases at a
decreasing rate

Maximizing Total Utility Maximizing Total Utility

– Figure 3.1(b) The Utility-Maximizing Choice
MU can convert into $
illustrates Law of – We can find the utility-maximizing choice by
(utility)10=$1(price)
diminishing marginal looking at the total utility that arises from each
utility. affordable combination.
– As the quantity of
soda increases, the =D
– The utility-maximizing combination is called a
marginal utility from consumer equilibrium.
soda diminishes.
– Downward sloping
MU curve
 Maximizing Total Utility Maximizing Total Utility
– Table 3.2 shows Lisa’s – Lisa chooses the
3.2 3.2
utility-maximizing choice. combination that gives
– Lisa has $40 a month to her the highest total
spend on movies and utility.
soda. – Lisa maximizes her total
– The price of a movie is $8 utility when she sees
and the price of soda is 2 movies and drinks 6
$4 a case. cases of soda a month.
– Each row of the table – Lisa gets 90 units of
shows a combination of utility from the 2 movies
movies and soda that and 225 units of utility
exhausts Lisa’s $40. from the 6 cases of soda.

Maximizing Total Utility Maximizing Total Utility

– The Utility-Maximizing Rule:
• Choosing at the Margin
– Call the marginal utility of movies MUM .
– A consumer’s total utility is maximized by
following the rule: – Call the marginal utility of soda MUS .
Spend all available income(Budget). – Call the price of movies PM .
– Call the price of soda PS .
Equalize the marginal utility per dollar for all
goods. – The marginal utility per dollar from seeing movies is
– The marginal utility per dollar is the marginal MUM/PM .
utility from a good divided by its price. – The marginal utility per dollar from soda is MUS/PS.
 Maximizing Total Utility Maximizing Total Utility
3.3 – If (6.25)MUM/PM > (2.5)
– Total utility is MUS/PS ,(at Option B) 3.3
maximized when:
– then spend less on soda and
– MUM/PM = MUS/PS more on movies.
– Table 3.3 shows why – MUM decreases and
the utility-maximizing
rule works. – MUS increases.
– The combination is
each row is affordable – Only when
(costs $40). MUM/PM = MUS/PS,
is it not possible to reallocate
– In row C, the budget and increase total
– MUM/PM = MUS/PS = 5. utility.

Maximizing Total Utility Predictions of Marginal Utility Theory

3.3
– If (6)MUS/PS > (4)MUM/PM,(at • A Fall in the Price of a Movie
option D) – When the price of a good falls the quantity demanded
– then spend more on soda and of that good increases—the demand curve slopes
less on movies. downward. (according to Law of demand)
– MUS decreases and – For example, if the price of a movie falls, we know that
[MUM/PM ]rises, so before the consumer changes the
– MUM increases.
quantities bought, MUM/PM > MUS/PS.
– Only when – To restore consumer equilibrium (maximum total
MUM/PM = MUS/PS, utility) the consumer increases the movies seen to
is it not possible to reallocate drive down the MUM and restore
the budget and increase total MUM/PM = MUS/PS.
utility.
 Predictions of Marginal Utility
Predictions of Marginal Utility Theory
Theory
– A change in the price of one good changes the – Table 3.4 shows Lisa’s
3.4

demand for another good. affordable combinations NEW

– You have seen that if the price of a movie falls, when the price of a
MUM/PM rises, so before the consumer changes movie is $4.
the quantities consumed, MUM/PM > MUS/PS. – Before Lisa changes
what she buys
(10)MUM/PM > (5)MUS/PS.
– To restore consumer equilibrium (maximum total – To maximize her total
utility) the consumer decreases the quantity of utility, Lisa sees more
soda consumed to drive up the MUS and restore movies and drinks less
soda.
MUM/PM = MUS/PS.
$4(6) +$4(4) = $40
$4(7) +$4(5)=$48>$40 $4(8) +$4(6)=$56>$40

Predictions Predictions of Marginal Utility Theory

– Figure 3.2 illustrates these
predictions. • A Rise in the Price of Soda
– A fall in the price of a movie – Now suppose the price of soda rises.
increases the quantity of movies
demanded – We know that [MUS/PS ] falls, so before the
—a movement along the demand consumer changes the quantities bought, MUS/PS
curve for movies, < MUM/PM.
– To restore consumer equilibrium (maximum total
– and decreases the demand for utility) the consumer decreases the quantity of
soda soda consumed to drive up the MUS and increases
—a (leftward)shift of the demand the quantity of movies seen to drive down MUM.
curve for soda. (with no change in
Ps) – These changes restore MUM/PM = MUS/PS.
Movie and Soda are substitutes
 Predictions of Marginal Utility Theory Predictions of Marginal Utility Theory
– Table 3.5 shows Lisa’s 3.5 – Figure 3.3 illustrates
affordable($40)
combinations when the these predictions.
NEW
price of soda is $8 a case – A rise in the price of
and a movie is $4. soda decreases the
– Before Lisa changes what 10.00 quantity of soda
she buys demanded—a
(6)MUM/PM > (3)MUS/PS. movement along the
– To maximize her total utility, SAME demand curve
Lisa drinks less soda $8(2)+$4(6)=$40 for soda.
(with no change in movie).

Predictions of Marginal Utility

Predictions of Marginal Utility Theory
Theory
– Table 3.6 shows Lisa’s
• A Rise in Income affordable 3.6
– When income increases, the demand for a normal combinations when she
has $56 to spend.
good increases. (positive relationship)
– With $40 to spend, Lisa
– Given the prices of movies and soda, when Lisa’s sees 6 movies and
income increases from $40 a month to $56 a drinks
4 cases of soda a month.
month, she buys more movies and more soda. – With $56 to spend, Lisa
– Assume Movies and soda are normal goods. spends the extra $16.
– Table 3.6 shows these predictions. – She sees 8 movies and
drinks 6 cases of soda a
month.
MUM/PM = MUS/PS =5
$4*(7)+$45)=$48<$56 $4(8) +$4(6) =$56
 Predictions of Marginal Utility Theory Exercise
As income increases, both demand curves shift to the right at given price • Table 1 shows Jerry’s total utility from burgers
– Figure 3.4 illustrates these predictions. and magazines.

26

a) Calculate Jerry’s marginal utility from Burger in the week.

$12-$4(M)-$2(B)-($4+$2)(B+M)=$0
If B=$14
b) If the price of a burger is $2, calculate the marginal utility Burger(B) Magazine(M)
per dollar spent on burgers when Jerry buys 2 burgers a Q TUB MUB MU/P Q TUM MUM MU/P
week. ($2) ($4)
0 0 n/a n/a 0 0 n/a(-) n/a
c) Calculate Jerry’s marginal utility from magazine in the
week. 1 14 14 7 1 100 100 25
2 24 10 5(b) 2 120 20 5(d)
d) If the price of a magazine is $4, calculate the marginal 3 32 8 4 3 134 14 3.5
utility per dollar spent on magazines when Jerry buys 2
4 38 6 3 4 144 10 2.5
magazines.
(a) (c)

e) When the price of a burger is $2, the price of a magazine is

$4, and Jerry has $12 a week to spend, Jerry buys 2 (e)Yes; Jerry will consume 2 burgers and 2 magazines subject to budget
burgers and 2 magazines. Does he maximize his total utility? constraint.$2*2 + $4*2 =$12
MU/P of burger is equal to MU per of Magazine(=5)
Explain your answer. Jerry will maximize his total utility(24+120=144) in consuming both goods

27 MU= change in TU/ Change in one unit