1 of 8 Principles of Microeconomics: Econ102

Utility: The enjoyment or satisfaction that people receive from consuming goods and services. Marginal utility: The additional utility a person receives from consuming one additional unit of a good or service. It is an important concept in understanding why a given product has the market value that it does…….refer to diamond-water paradox. Law of diminishing marginal utility: Consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time. 2 of 8

For nearly every good or service, the more you consume during a period of time, the less you increase your total satisfaction from each additional unit you consume. Total Utility from Eating Pizza and Drinking Coke NUMBER OF SLICES OF PIZZA TOTAL UTILITY FROM EATING PIZZA MARGINAL UTILITY FROM THE LAST SLICE NUMBER OF CUPS OF COKE TOTAL UTILITY FROM DRINKING COKE MARGINAL UTILITY FROM THE LAST CUP of 8

Total and Marginal Utility from Eating Pizza on Super Bowl Sunday 4 of 8

………..if it is true that you buy up to that unit at which the marginal benefit (utility) is equal to the price, and it is true that the marginal benefit (utility) diminishes as more of the product is bought, then the price must fall in order to induce you to buy the next unit…………….wow, that is so cool!! The Law of Diminishing Marginal Utility tells us that consumers will be willing to pay less for subsequent units of a good or service. 5 of 8

It is responsible for the development of The Law of Diminishing Marginal Utility. The value of a product in a market is determined by its marginal utility, not by its total utility. On the one hand, the value of water is not determined by the total value of all water on the planet. Instead, it is determined by the marginal utility of the very last gallon of water. On the other hand, the total value of all the diamonds on the planet is not as large as it is for water. However, the value of the last carat of a well-cut diamond is very high because there is so little of it. 6 of 8

The key to making the best consumption decision is to maximize utility by following the rule of equal marginal utility per dollar: As you decide how to spend your income, you should buy pizza and coke up to the point where the last slice of pizza and coke purchased give you equal increases in utility per dollar or where: (1) Slices of Pizza (2) Marginal Utility (MU Pizza ) (3) Marginal Utility per Dollar (4) Cups of Coke (5) Marginal Utility (MU Coke ) (6) Marginal Utility per Dollar  6 11 Budget Constraint = $10.00; Pizza = $2.00/slice; Coke = $1.00/unit 7 of 8

We can compactly summarize the two conditions for maximizing utility as follows: Spending on pizza + Spending on Coke = Amount available to be spent Combinations of Pizza and Coke with Equal Marginal Utilities per Dollar Marginal Utility per Dollar (Marginal Utility/Price)Total SpendingTotal Utility 1 Slice of Pizza and 3 Cups of Coke10$2 + $3 = $ = 65 3 Slices of Pizza and 4 Cups of Coke5$6 + $4 = $ = 96 4 Slices of Pizza and 5 Cups of Coke3$8 + $5 = $ = of 8