ECON 1000 Lecture Notes - Bounded Rationality, Neuroeconomics, Marginal Utility

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7 Nov 2011
Chapter 8
Maximizing Utility
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 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.
Total utility from a good increases as the quantity of the good increases.
Marginal Utility
Marginal utility is the change in total utility that results from a one-unit increase in the
quantity of a good consumed.
As the quantity consumed of a good increases, the marginal utility from consuming it
decreases. (utility has been divided into more part, thus, marginal utility decrease)
We call this decrease in marginal utility as the quantity of the good consumed increases the
principle of diminishing marginal utility.
The Utility-Maximizing Choice
We can find the utility-maximizing choice by looking at the total utility that arises from each
affordable combination.
The utility-maximizing combination is called a consumer equilibrium.
Choosing at the Margin
A consumers total utility is maximized by following the rule:
Spend all available income.
Equalize the marginal utility per dollar for all goods.
The marginal utility per dollar is the marginal utility from a good divided by its price.
Total utility is maximized when good A and good B have the same marginal utility per dollar.
If MUa/Pa > MUb/Pb, then MUa decrease and MUb increase
If MUa/Pa < MUb/Pb, then MUa increase and MUb decrease
Predictions of Marginal Utility Theory
A Fall in the Price of a Movie
When the price of a good falls the quantity demanded of that good increases—the demand
curve slopes downward.
For example, if the price of a movie falls, we know that MUm/Pm rises, so before the
consumer changes the quantities bought, MUm/Pm > MUp/Pp.
To restore consumer equilibrium (maximum total utility) the consumer increases the movies
seen to restore MUm/Pm = MUp/Pp.
A Rise in the Price of Pop
We know that MUp/Pp falls, so before the consumer changes the quantities bought,
MUp/Pp < MUm/Pm.
To restore consumer equilibrium (maximum total utility) the consumer decreases the
quantity of pop consumed to and increases the quantity of movies seen to drive down MUm.
These changes restore MUm/Pm = MUp/Pp.
A rise in the price of pop decreases the quantity of pop demanded—a movement along the
demand curve for pop.
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