Chapter 8 Utility and Demand
The choices you make as a buyer of goods and services are influenced by
o Consumption Possibilities
Consumption possibilities are all the things that you can afford
to buy. Everything you can buy is limited by your income and
by the prices you must pay.
A 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. Fig 8.1 pg 180.
When prices or income change, consumption also changes, a
rise in income shifts the budget line outward but leaves the
A change in price changes the slope of the line.
A choice that she makes depending on preference- what she
likes and dislikes.
Utility- the benefit or the satisfaction a person gets from the
consumption of goods or service.
Total Utility- The benefit that a person gets from the
consumption of all the different goods and services.
More consumption gives more total utility.
Marginal Utility- The change in total utility that results
from a one-unit increase in the quantity of a good
Marginal utility is positive but It diminishes as the
quantity of a good is increased. Some objects have
negative utility, hard labour and pollution,: total utility
increases as quantity consumed increases.
Diminishing marginal utility-the tendency for
marginal utility to decrease as the consumption of a
good increases. The principle of diminishing marginal
Consumers want to get the most utility possible from their limited resources.
They make choices that maximizes utility.
Spread Sheet solution fig 8.2 pg 183
o Find the just-affordable combinations
o Find the total utility for each just-affordable combination
Adding both utilities from each activity or product. By doing
this you can find the combination that will maximize total
o Consumer Equilibrium Consumer Equilibrium- is a situation in which a consumer
has allocated all of his or her available income in a way that
maximizes his or her utility, given the price of goods or
To find consumer equilibrium you select the combination that
gives the highest total utility.
Choosing at the Margin
Allocating your budget the best way possible.
Marginal Utility per Dollar
o Economists interpret your best possible choice by using the idea of
marginal utility per dollar.
o Marginal Utility per dollar is the marginal utility from a good that
results from spending one more dollar on it.
o Using marginal analysis a consumer’s total.
o The increase in total utility results from spending one more dollar at
the pump is the marginal utility per dollar from gasoline.
o Ex to calculate marginal utility per dollar for movies (or pop) you
must divide marginal utility from the good by its price
o for pop m would be replaced with p
o MU= marginal utility P= Price
Utility Maxing Rule
A consumers total utility is maximized by following rule:
o Spend all the available income
More consumption brings more utility, only those choices that
exhaust income can maximize utility.
o Equalize the marginal utility per dollar for all goods.
If buying more of good A decrease its MU, and buying less of
good B increases its MU, than moving dollars from good A to
good B total utility rises.
o Marginal Utility is maximized when =
The power of Marginal Analysis
THE RULE IS SIMPLE: if marginal utility per dollar from movies exceeds the
marginal utility per dollar from pop, see more movies and buy less pop.
We don’t need to ask Lisa to tell us her preferences
We can figure them out for ourselves by observing what she buys at various prices
The units in which we measure Lisa’s preferences don’t matter—any arbitrary units
When Lisa maximizes her total utility, her marginal utility per dollar from pop equals
her marginal utility per dollar from movies
MUp/Pp = MUm/Pm
Multiply both sides of this equation by the price of pop to obtain
MUp=MUm x (Pp/Pm) This equation says that the marginal utility from pop is equal to the marginal utility
from movies, multiplied by the ratio of the price of pop to the price of a movie
The ratio Pp/Pm is the number of movies that must be forgone to get 2 case of pop (also
the opportunity cost of pop)
For Lisa, the marginal utility from 6 cases of pop equals ½ of the marginal utility from
Predictions of Marginal Utility Theory
Marginal utility theory predicts the law of demand
The theory also predicts that a fall in the price of a substitute of a good decreases the
demand for the good and that for a normal good, a rise in income increases demand
All these affects are predictions of marginal utility theory
To derive these predictions, we study the effects of 3 events
•A fall in the price of a movie
•A rise in the price of pop
•A rise in income
A Fall in the Price of a Movie
With no change in her $40 income and no change in the price of pop, the price of a
movie falls from $8 to $4
Finding the New Quantities of Movies and Pop
1) Determine the just-affordable combinations of movies and pop at the new
2) Calculate the new marginal utilities per dollar from the good whose price has
3) Determine the quantities of movies and pop that make their marginal utilities
per dollar equal
The lower price of a movie means that Lisa can afford more movies or more pop
Lisa can afford any of the combinations shown in the rows of Table 8.3
New Marginal Utilities Per Dollar From Movies
A person’s preferences don’t change just because a price has changed
With no change in her preference, Lisa’s marginal utilities in Table 8.3 are the same as
those in Table 8.1
Because the price of a movie has changed, the marginal utility per dollar from movies
The marginal utility per dollar from movies has doubled
Equalizing the Marginal Utilities Per Dollar
If Lisa sees 6 movies and buys 4 cases of pop a month (row c), her marginal utility per
dollar from movies (6 units) equals her marginal utility per dollar from pop and she is