Chapter 8: Utility and Demand
Your consumption choices are categorized under two broad headings:
All the things you can afford to buy (which are different combinations of goods and
services that are limited by your income and the prices that you must pay)
A Consumer’s Budget Line
Marks the boundary between those combinations of goods and services that a
household can afford to buy and those that it cannot afford. As you move along the
BL, the number of goods and services change in correlation to each other (giving up
one for the other)
It marks the boundary between what is affordable and unaffordable for someone.
All the points on and under it are affordable whereas the points above it are
Changes in Consumption Possibilities
Consumption possibilities change when income or price changes.
A rise in income shifts the budget line left but leaves the slope unchanged.
A change in price changes the slope of the line.
The budget line shows what is possible; [references determine which possibility is
The goal of a theory of consumer choice is to derive the demand curve from a
deeper account of how consumers make their buying plans. That is, we want to
explain what determines demand and marginal benefit.
One approach: Utility: benefit or satisfaction that a person gets from the
consumption of goods and services
Is the total benefit that a person gets from he consumption of all different goods and
services. (more consumption generally gives more total utility)
We can measure this by giving a value to a certain amount of a good and asking one
to use the given units to measure total utility (ex. 1 movie is 50 units, 2 movies is 90
units, 3 movies is 122 units..)
Is the change in total utility that results from a one-unit increase in the quantity of a
Subtract the total utility from another as you increase by one unit (90-50=40 units,
Positive marginal utility: total utility increases as the quantity consumed increases
Diminishing marginal utility: as total utility increases, marginal utility decreases Utility-Maximizing Choice
A Spreadsheet Solution
Find the Just-Affordable Combinations
All the rows on a table show combinations that exhaust one’s budget.
Find the Total Utility for Each Just-Affordable Combination
Add up the two total utilities from each service or good.
Is a situation in which a consumer has allocated all of his or her available income in
the way that maximizes his or her total utility, given the prices of goods and services
(point on table where total utility is highest).
Choosing at the Margin
Marginal Utility per Dollar
Marginal utility is the increase on total utility that results from consuming one more
unit of a good…whereas the marginal utility per dollar from a good that results from
spending one more dollar on it.
To calculate marginal utility/marginal utility per dollar: MU/P
(Marginal utility from the good/its price)
Spend all available income: exhaust all income to maximize utility
Equalize the Marginal Utility per Dollar: highest total utility between both goods
Higher up on the budget line; too much good X and total utility would increase by
receiving more good Y
Lower on budget line; too much good Y and total utility would increase by receiving
more good X
By picking point by using utility maximizing rule, you cannot move from that point
without making yourself worse off (where marginal utility per dollar of good X equal
“ of good Y)
The Power of Marginal Analysis
If marginal utility per dollar from good X exceeds the marginal utility per dollar
good Y, do more good X and less good Y (and vice versa)
More generally, if the marginal gain from an action exceeds the marginal loss, take
MU =YU X XP /P Y X
-This equation says that the MU from good Y is equal to MU of good X multiplied by
the relative price of good Y in term of good X (number of good X that must be
forgone to get 1 good Y) Predictions of Marginal Utility Theory
The marginal utility theory predicts:
1) the law of dema