# 1 Chapter 5 Marginal Utility & Consumer Choice 5/23/2015 © ©1999 South-Western College Publishing.

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1 Chapter 5 Marginal Utility & Consumer Choice 5/23/2015 © ©1999 South-Western College Publishing

2 What is Utility? The satisfaction or enjoyment a person obtains from consuming a good © ©1999 South-Western College Publishing

3 What is a Util? A hypothetical unit used to measure how much utility a person obtains from consuming a good © ©1999 South-Western College Publishing

4 What is Marginal Utility? The change in total utility a person derives from consuming an additional unit of a good © ©1999 South-Western College Publishing

5 What is Total Utility? The total number of utils a person derives from consuming a specific quantity of a good © ©1999 South-Western College Publishing

6 TU and MU Q TU MU 0 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2

7 What is the Law of Diminishing Marginal Utility? As more of a good is consumed, at some point, the marginal utility a person derives from each additional unit diminishes

8 Does the Law of Diminishing Marginal Utility apply to all goods consumed? YES © ©1999 South-Western College Publishing

9 9 Total Utility Quantity TU

10 10 Marginal Utility MU

11 Demand Curve D P1 Q1 P2 Q2 11 © ©1999 South-Western College Publishing

12 Why does MU = P explain the downward sloping demand curve? © ©1999 South-Western College Publishing

13 If you are hungry for a Shawarma, how many Shawarmas will you buy? Up to where your MU = P © ©1999 South-Western College Publishing

14 Why? Shawarma Because if MU > P you will buy another Shawarma Shawarma If MU < P you will not buy that last Shawarma © ©1999 South-Western College Publishing

15 P1 P2 Q1 Q2 15 © ©1999 South-Western College Publishing MU At P1, consume to Q1, since MU > P up to that point, at P2, consume to Q2, etc.

16 Consumer equilibrium Now go from 1 good to 2 or more goods: have to take prices of good into account

17 Consumer equilibrium condition Purchase X and Y in amounts such that MU x = MU y P x P y Why?

18 Assume you are not in equilibrium… say that MU x > MU y P x P y What would you do??

19 Purchase more of X (due to its greater satisfaction per dollar), and less of Y But more of X reduces MU X and less of Y increases MU Y so we are heading back to equilibrium!!

20 For more than 2 goods, the equilibrium condition becomes….. MUx/Px = Muy/Py = Muz/Pz = …….for all goods

21 In other words, when is your Total Utility maximized? When the last dollar spent on each good yields the same marginal utility © ©1999 South-Western College Publishing

22 Applications of Utility The water-diamond paradox--why is water so cheap and diamonds so expensive?

23 Water-high TU but low MU due to abundance, diamonds the opposite- Price reflects marginal valuation, not totals

24 What statement do these sites make about the marginal utility of diamonds? http://www.rostar.com http://www.usdiamond.com © ©1999 South-Western College Publishing

25 The marginal utility of money? Does it diminish as with goods?

26 Diminishing MU of money often used as an argument for progressive taxation.

27 What is Interpersonal comparison of utility? A comparison of the marginal utility that different people derive from a good or a dollar © ©1999 South-Western College Publishing

28 Economists argue that we should avoid such interpersonal utility comparisons

29 What is Consumer Surplus? The difference between the maximum amount that a consumer is willing to pay for something and what he actually pays © ©1999 South-Western College Publishing