Chapter 8- Utility and Demand
- The choices you make as a buyer of good and services is influenced by many factors, which
economists summarize as
o Consumption possibilities
- Consumption possibilities are all the things that you can afford to buy.
- We’ll study the consumption possibilities of Lisa, who buys only two good; movies and pop.
A consumer’s budget Line
- Consumption possibilities are limited by income, the price of a moive and the
price of a pop.
o When Lisa spends all of her income, she reaches the limits of her
o Lisa’s budget line shows the limits of her consumption possibilities
o Lisa has $40 to spend, the price of a movie is 48 and the price of a pop
is $4 a case.
o The table lists seven possible ways Lisa can spend her $40.
o The graph plots these combinations of movies and pop
o Lisa can afford any of the combinations from A to F
o Some goods are indivisible and must be bought at whole units at the
o Other foods are diviable, and can be bought at any quantity
o The line through a to F shows Lisa’s budget line.
- The budget line is a constraint on Lisa’s budget choices
- Lisa can afford any point on her budget line, or inside it.
- Lisa can not afford any point ouside her budget line
- The choice that Lisa makes depends on her preferences- her likes and dislikes
- Her benefit or satisfaction from consuming a good or service is called a utility
- Total utility is the total benefit a person gets from the consumption of goods. Generally, more
consumption gives more total utility Maximizing Utility
- The table shows Lisa’s total utility schedule
- Total utility from good increases as the quantity of the good increases.
o As Lisa sees more movies month, her total utility form movies
increases, and from pop decreases
- Marginal Utility from a good is the change in total utility that results from a
unit-increase in the quantity of the good consumed
- As the quantity consumed of a good increases, the marginal utility from it decreases.
- We call this decrease in marginal utitity as the quantity of the
good consumed increases the diminishing marginal utility
- Marginal utility from good decreases as the quantity of the
o As the number of movies seen in a month increases,
marginal utility from movies decreases
- The graph illustrates Lisa’s total utility and marginal utility
o Total utility from a pop increases as more pop is
o The bars along the total utility curve show the extra
total totality (marginal utility) from each additional case
- The bar graph illustrates diminishing marginal utility
o As Lisa increases the quantity of pop she drinks, her
marginal utility from pop diminishes
- The key assumption is that the household chooses the
consumption possibility that maximizes total utility
- The direct way to find the utility-maximising choice is to make a table in a
spread sheet to do the calculations
o Find the just-affordable combinations
Lisa has $40 a month to spend
The price of a movie is $8 and pop $4
Each roc shoes a combination that exhausts Lisa’s $40
o Find the total utility for each just-affordable combination
When Lisa sees 1 movie and drinks 8 cases a month....
She gets 50 units of utilities from the 1 movie and 248 units
of utility from the pop Totaling 298 units
o Consumer equilibrium
Lisa chooses the combination that gives her the highest total utility
Lisa maximises her total unitary when she sees 2 movies and drinks 6 cases of
pop a month
Lisa get 90 units of totality from the movies and 225 from pop
o The utility-maximizing combination is the consumer’s choice
Choosing at the margin
- A More natural way of finding the consumer equilibrium is to use the idea of choices made at
- Having made a choice, would spending a dollar more or a dollar less on a good bring more total
- Marginal utility is the increase in the total utility that results from consuming one more unit of
- The Marginal utility of per dollar is the marginal utility from a good that results from spending
one more dollar on it
- The marginal utility per dollar equals the marginal utility from a good divided by its price
- Calling the marginal utility from movies MUMand the price of a movie PMthen the marginal
utilities from movies is MU / P
- Calling the marginal utility of pop MP and price P .
- Comparing MU / m anM MU / P wp caP determine whether Lisa has allocated her budget the
way that maximizes her total utility
Utility maximizing rule
- A consumer’s total ability is maximized by the following rule:
o Spend all available income
o Equalize the marginal utility per dollar for all goods
- Lisa marginal calculation
o Each row of the table shows a just-affordable combination
o Start by choosing a row-a point on the budget line.
o In row B1
MU m P MMU / Pp P
Too much on movies, too little on pop
o In row C1
MU / P = MU / P
m M p P Lisa maximizes her total ut