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Chapter 7

Chapter 7. Utility Maximization. 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.

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Chapter 7

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  1. Chapter 7 Utility Maximization

  2. 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

  3. Terminology • Utility is the satisfaction one gets from consuming a good or service • Not the same as usefulness • Subjective • Difficult to quantify LO1

  4. 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

  5. 30 20 Total utility (utils) ] ] ] ] ] ] ] 10 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7 10 8 6 Marginal utility (utils) 4 2 0 -2 Total Utility and Marginal Utility Continued Total Utility (1) Tacos Consumed Per Meal (2) Total Utility, Utils (3) Marginal Utility, Utils TU 0 10 18 24 28 30 30 28 0 1 2 3 4 5 6 7 10 8 6 4 2 0 -2 MU LO1

  6. Theory of Consumer Behavior • Rational behavior • Preferences • Budget constraint • Prices LO2

  7. Utility Maximizing Rule • 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 MU of product B Price of A Price of B = LO2

  8. Numerical Example LO2

  9. Decision-Making Process LO2

  10. $2 Quantity Demanded Price per Orange Price per orange $1 DO 0 4 6 Quantity demanded of oranges Deriving the Demand Curve 4 $2 6 1 LO3

  11. 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 has on a product’s relative expensiveness LO4

  12. Applications and Extensions • New products • iPad • Diamond-water paradox • Opportunity cost and time • Medical care purchases • Cash and noncash gifts LO5

  13. 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

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