UTILITY • Utility is satisfaction. • We get utility from the consumption of goods and services. • We aim to maximise our total utility. • Utility can be measured in units called “Utils”
MARGINAL UTILITY • Marginal utility is the extra satisfaction we get from consuming one more unit of a good. • The law of diminishing marginal utility states that as we consume more of the same good MU will begin to fall. MU $ units
Example • Sam loves cream donuts. The first donut he eats gives him 18 utils of satisfaction. The second donut gives him 12 utils of satisfaction. The third donut gives him 7 utils of satisfaction and the fourth donut gives him 1 util . • Copy and complete the table below then draw Sam's total and marginal utility graphs Total and marginal Utility Number of donuts
Copy and complete the following statements • Marginal Utility __________ as more donuts are consumed • Total Utility ____________ as more donuts are consumed but at a ____________ rate • Total Utility will be the greatest when Marginal Utility equals ____ • Total Utility will fall if marginal utility is ___________ Falls increases Slower 0 Negative
Total Utility and Marginal Utility When TU is maximum MU = 0 $ $ TU Q Q q1 q1 MU
Putting a $ Value on Utility • A person can put a dollar value on personal satisfaction from consuming an item. • This value will be different for each person based on their personal preferences (i.e. Sam really likes cream donuts so may put on a higher dollar value on cream donuts than his workmate.
Example – Sam values each util at 50cents Complete the final column in the table below 9 6 3.50 0.50 How many donuts will sam buy if the market price is each of the following ( Remember MU$ in the chart above represents sams personal satisfaction ($ value) from the last donut) $8 =__________ $5 = __________ $2 = __________ 1 2 3
OPTIMAL PURCHASE RULE • A consumer will consume to the point where P = MU. • A consumer will only buy extra units if their value of personal satisfaction from the extra unit is above or equal to the price they have to pay.
Using the Optimal Purchase Rule to find a persons Demand for a good or service • A persons demand for a good or service can be defined as • The amount of a good or service that a person is willing and able to buy at each price level • Marginal Utility will determine a person’s demand for a good or service. • An individual demand curve is the same as their marginal utility (dollars) curve.
Illustration Exercise • Complete the worksheet and stick into your notes
DEMAND • Using P=MU and a consumers MU curve we can derive their demand. Mu $ P $ unit D mu Q
Demand and Marginal Utility • The price that a person is willing to pay for a extra unit is determined by their marginal utility from that unit • Earlier units of consumption have a higher marginal utility therefore consumers are willing to pay a higher price • Consumers will only by a extra unit of a good or service if the price falls……....... • This leads to the law of demand
Law of demand • As price increases quantity demanded will decrease ( because consumers can’t afford as much with their income) Vice versa, ceteris paribus • As price increases MU/P falls, so we buy less. If we are consuming at P=MU and price rises then P>MU so we buy less until P=MU
Consumer Equilibrium • Consumer equilibrium occurs when the satisfaction from total spending by a consumer is maximised for a given level of income • Optimal purchase rule – a consumer will consume up to the point where Price = $MU • When buying many goods, a persons satisfaction is maximised when the last dollar spent on each good gives the same amount of satisfaction. • Consumers are getting the most satisfaction from their total spending and have maximised their total utility
PARADOX OF VALUE • It seems puzzling that water, which is essential for life, has a low value, whereas diamonds, which are not essential have a very high value. Because we consume water in such large quantities, the MU is low. Diamonds however are consumed in small amounts and so have a very high MU.
DESCRIBE • The trend for total utility as a person consumes more and more of a product. • The trend for marginal utility as a person consumes more and more of a product. • The trend for quantity demand as price falls. • The trend for the consumption of an inferior good as income increases. • The trend for the consumption of a normal good as income increases.
EXPLAIN • Why consumers increase their quantity demand as price falls.
Vocabulary Utility • Satisfaction from consumption of a good or service. • As more of a good is consumed, the extra satisfaction decreases. • The quantity a persons is able and willing to buy at a given price. law of diminishing marginal utility individual demand
Vocabulary optimal purchase rule • A consumer will purchase up to the point where MU=P • A product used in place of another. • A product often used in conjunction with another. substitute complement