1. Total and Marginal Utility
Consumer Behavior
Total and Marginal Utility

2. Theory of Consumer Choice
Both Budget Constraints and Consumer Preferences can be graphed:
The slope of the budget constraint = the rate at which one consumer can trade off one good for another
AND
The relative prices of the two goods
(PSSSTTT – The secret? Same shape as a Production Possibilities Curve)
Consumer preferences = “The Indifference Curve”

3. Theory of Consumer Choice
Consumer Income is limited but choices are numerous
Consumers must combine budget constraints and preferences

4. Budget Curve and Indifference Curve
Budget Constraint Curve
Good X
Indifference Curve
Good Y

5. Budget Curve and Indifference Curve

6. UTILITY MAXIMIZATION So How Do We Know…
Where our budget constraints and indifference curve meet:
UTILITY MAXIMIZATION

7. REVIEW! Utility - DEFINITION
The measurement of happiness or satisfaction derived from consuming a good or a service
Added satisfaction declines as a consumer acquires additional units of a given product
LAW OF DIMINISHING MARGINAL UTILITY

8. Things to keep in mind… “Utility” and “usefulness” are not synonymous
Utility is subjective
Utility is difficult to quantify (but still…units of utility are named utils. Those economists are clever if not creative!)

9. Total vs. Marginal Utility
Total Utility =
Total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service (measured in UTILS!)
Marginal Utility =
Extra amount of satisfaction a consumer realizes from an additional unit of that product
Or…the change in total utility that results from the consumption of 1 more unit of product

10. Things to keep in mind (Part II)…
Different goods and services result in different RATES of diminishing marginal utility
EX: Bottled water might decrease in terms of marginal utility at a rate SLOWER than the change in the marginal utility of chewing gum

11. Consumer Behavior
Diminishing marginal utility also explains how customers allocate their money incomes among many goods and services
Utility is restrained by consumer choice and behavior:

12. Consumer Choice and Budget
Rational behavior
Rational consumers attempt to derive the greatest amount of satisfaction based on choice and budget
Preferences
Consumers have clear cut preferences which influence their choices
Budget constraint
Consumers have fixed/limited amount of money income which influences their choices (scarcity!)
Prices
Every good or service has a price tag which influences consumer choice

13. Maximizing Total Utility
As a result of these constraints…
Consumers seek to maximize their total utility by combining purchases of goods and services
To maximize utility:
Allocate the available budget in a way that maximizes total utility
Choose affordable combinations of goods which the sum of the utilities obtained from all goods and services consumed is as large as possible

14. Utility Maximizing Rule
To maximize utility:
A consumer must allocate the ENTIRE available budget
Last dollar spend on each product yields the same amount of extra (marginal) utility
Consumer equilibrium
Formula
MU of product A = MU of product B
Price of A Price of B Or
MUx = MUy
Px Py

15. Example Budget Constraint = $10 Apple Price (Product X) = $1
Orange Price (Product Y) = $2
Unit of Product
Marginal Utility in Utils
Marginal Utility per $ (MU/Price)
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
Budget Constraint = $10

16. Example Choice Number Potential Choices Marginal Utility per $
Purchase Decision
Income Remaining 1
1st apple
1st orange 10 12
1st orange for $2
$8 ($10 - $2) 2
2nd orange
1st apple for $1
2nd orange for $2
$5 ($8 - $3) 3
2nd apple
3rd orange 8 9
3rd orange for $2
$3 ($5 - $2) 4
4th orange
2nd apple for $1
4th orange for $2
$0 ($3 - $3)

17. Utility Maximizing Rule
Last dollar utility:
For apples = 8 utils
For oranges = 8 utils (16/$2)
MUx = Muy
Px Py
8 Utils = 16 utils
$ $2

18. Budget Curve and Indifference Curve
Budget Constraint Curve
Utility Maximization Point
Apples
Indifference Curve 2 4
Oranges

19. Practice Problem #1 Quantity of Cookies Total Utility of Cookies
Quantity of Cupcakes
Total Utility of Cupcakes 1 10 26 2 18 46 3 24 62 4 66
Assume the price of a cookie is $1
Assume the price of a cupcake is $2
Budget is $8. All of this budget will be spent
Using Socrative, answer the questions regarding consumer preference

20. Practice Problem #2
Assume the price of a pizza is $2.00 and the price of soda is $ At your current levels of consumption, the Marginal Utility from pizza is 10 utils and the Marginal Utility from Soda is 6. Which should you consume more of: Pizza or Soda
MUp/Pp = ?
10/2 = 5
MUs/Ps = ?
6/1 = 6
Consume more ?
Soda
Consume less ?
Pizza
Why???
Total Utility increases with soda consumption

21. Practice Problem #3
The price of steak is $7 per pound and the price of chicken is $2 per pound. Your mother currently receives a marginal utility of 14 utils from consuming steak this week and 6 utils from consuming chicken. Should your mother buy less chicken this week?
No – MU per$ is 2 for steak and 3 from chicken
Should buy more chicken and less steak to increase total utility

22. Practice Problem #4 Apples (price of apples = $.50)
Grapefruit (price of grapefruit = $1.00)
Qty of Apples
TU of Apples
MU of Apples
MU/$ of Apples
Qty of GF
TU of GF
MU of GF
MU/$ of GF 1 10 20 25 2 18 8 16 40 15 3 7 14 53 13 4 30 5 63 34 68 6 37 71 39 73 74
You have $6.00 to spend. At what combination do you maximize utility?
Remember MUx/Px = MUy/Py!
Which combination maximizes our utility? Why?