1. Utility Maximization Module KRUGMAN'S MICROECONOMICS for AP* Micro: 1551
Module
Utility Maximization
KRUGMAN'S
MICROECONOMICS for AP*
Margaret Ray and David Anderson

2. What you will learn in this Module:
How consumers make choices about the purchase of goods and services
How does our satisfaction change as we consume greater quantities of a product? Or, when should we stop?
How do we choose how much of each different product to consume?
How do we find the optimal consumption bundle?
The purpose of this module is to introduce the concept of utility and the theory of consumer choice. Students will learn how utility-maximizing consumers choose to purchase bundles of goods and services, given a budget constraint.

3. Do Now
Graph Sherry’s utility from berry consumption. #1 in the worksheet.
Utility is a subjective notion in economics, we don’t expect to really measure it, but consumers know when utility is rising or falling, and they know when one choice provides more utility than another.

4. Maximizing utility
In the Theory of Consumer Choice, consumers’ goal is to maximize their utility.
Why do we demand particular goods and services? Because they make us happy and because we can afford them. Economists refer to this happiness as utility.

5. Utility
Utility: a measure of the satisfaction the consumer derives from consumption of goods and services.
Total utility: utility of total quantity consumed.
Marginal utility – utility of the last item consumed.
Utility is a subjective notion in economics, we don’t expect to really measure it, but consumers know when utility is rising or falling, and they know when one choice provides more utility than another.

6. Figure Cassie’s Total Utility and Marginal Utility Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

7. Marginal vs. Total Utility
How does marginal utility relate to total utility?
How does it help us make consumption decisions?
Why do we demand particular goods and services? Because they make us happy and because we can afford them. Economists refer to this happiness as utility.

8. Question
If you had two consumption choices, how would you decide the amount of each that you would consume?
Why do we demand particular goods and services? Because they make us happy and because we can afford them. Economists refer to this happiness as utility.

9. Let’s get real Consumption is limited by income – which is scarce.
The budget line: shows combinations of products that we can afford assuming we spend all of our income.
These combinations are called consumption bundles.
The budget line shows consumption possibilities.
The consumer’s challenge is two-fold:
1. Find the bundles of goods that are affordable, given income and prices, and
Choose the bundle that provides the highest utility.
Consumers want to maximize utility, but must do so within a budget constraint.

10. Figure The Budget Line Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

11. Practice Step 1 Krugman, page 527, Problem #17
Do A. Find the affordable consumption bundles, and
Graph.
The consumer’s challenge is two-fold:
1. Find the bundles of goods that are affordable, given income and prices, and
Choose the bundle that provides the highest utility.
Consumers want to maximize utility, but must do so within a budget constraint.

12. Figure Optimal Consumption Bundle Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

13. Utility Race
Step 2
If you graphed the total utility of each bundle, which one would you pick?.
The consumer’s challenge is two-fold:
1. Find the bundles of goods that are affordable, given income and prices, and
Choose the bundle that provides the highest utility.
Consumers want to maximize utility, but must do so within a budget constraint.

14. Spending the Marginal Dollar
Marginal utility per dollar.
MU= 10, cost = $5, MU / $1 = 2
Optimal consumption rule: consumption is optimal when the marginal utility per dollar of each product is equal. [And we’ve spent all of our money.]
The “utility maximization rule” says that the consumer should spend all of his income on two goods such that:
MU/P is equal for both (all) goods.
As long as one good provides more utility per dollar than another, the consumer will buy more of the first good; as more of the first product is bought, its marginal utility diminishes until the amount of utility per dollar just equals that of the other product.

15. Table Sammy’s Marginal Utility per Dollar Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

16. Figure Marginal Utility per Dollar Ray and Anderson: Krugman’s Economics for AP, First Edition Copyright © 2011 by Worth Publishers

17. Spending the Marginal Dollar
Problem #17 b
Also, solve for optimal bundle using zig zag method.
The “utility maximization rule” says that the consumer should spend all of his income on two goods such that:
MU/P is equal for both (all) goods.
As long as one good provides more utility per dollar than another, the consumer will buy more of the first good; as more of the first product is bought, its marginal utility diminishes until the amount of utility per dollar just equals that of the other product.

18. Summary Utility Total utility Maximized when MU = 0 Budget
Budget constraint
Consumption possibilities
Optimal
Marginal utility per $
Optimal consumption rule
The “utility maximization rule” says that the consumer should spend all of his income on two goods such that:
MU/P is equal for both (all) goods.
As long as one good provides more utility per dollar than another, the consumer will buy more of the first good; as more of the first product is bought, its marginal utility diminishes until the amount of utility per dollar just equals that of the other product.