2. ECON107 Principles of Microeconomics Week 9 NOVEMBER 2013 1 9w/11/2013 Dr. Mazharul Islam Chapter-8

3. 8 Utility and Demand Dr. Mazharul Islam 8w/11/2013

4. Lesson Objectives  Examine how individual consumers allocate their incomes among the various goods and services that available to them to get maximum utility ?  Given a particular budget, how does a consumer decide what goods and services to buy ? 3 Dr. Mazharul Islam 9w/11/2013

5. Issues of Discussion  Utility Defined  Total Utility  Marginal Utility  Subjective Nature  Difficult to Quantify  Law of Diminishing Marginal Utility 4 Dr. Mazharul Islam 9w/11/2013

6. Definitions  Utility: It reflects the benefit or satisfaction or pleasure of consumers that gets from goods and services.  Total utility is the total satisfaction a person derives from consumption. Generally, more consumption gives more utility.  Marginal utility is the change in total utility resulting from one-unit change in consumption of a good. As the quantity consumed of a good increases, the marginal utility from consuming it decreases. 5 Dr. Mazharul Islam 9w/11/2013

7. TOTAL AND MARGINAL UTILITY 6 Dr. Mazharul Islam 9w/11/2013 Total Utility, Utils Marginal Utility, Utils 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Units consumed per beef burger (BB) Units consumed per BB 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 TU MU 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7 Number Of glass

8. TOTAL AND MARGINAL UTILITY 7 Dr. Mazharul Islam 9w/11/2013 Total Utility, Utils Marginal Utility, Utils 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Units consumed per beef burger (BB) Units consumed per BB 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 TU MU 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7 Number Of glass Observe Diminishing Marginal Utility

9. Maximizing Utility  The key assumption of marginal utility theory is that the household chooses the consumption possibility that maximizes total utility.  The Utility-Maximizing Choice We can find the utility-maximizing choice by looking at the total utility that arises from each affordable combination.  The utility-maximizing combination is called a consumer equilibrium. 8 Dr. Mazharul Islam 9w/11/2013

10. Maximizing Utility Utility-Maximizing Condition  Consumer equilibrium is achieved when the budget is completely spent and Equalize the marginal utility per dollar for all goods. The marginal utility per dollar is the marginal utility from a good divided by its price.  Where MU p is the marginal utility of pizza, p p is the price of pizza, MU v is the marginal utility of videos, and p v the price of videos 9 Dr. Mazharul Islam 9w/11/2013

11. Maximizing Utility  If MU p / P p > MU v / P v, then spend more on pizza and less on videos. MU p will decrease and MU v will increase.  If MU p / P p < MU v / P v, then spend more on videos and less on pizza. MU p will increase and MU v will decrease. Only when, MU p / P p = MU v / P v, is it not possible to reallocate the budget and increase total utility. 10 Dr. Mazharul Islam 9w/11/2013

12. Utility Maximization  To see your income is allocated between two goods so as to maximize utility, suppose we start with some combination of pizzas and videos  If we can increase utility by reallocating our expenditures we will do so, and we will continue to make adjustments as long as utility can be increased  when no further utility- increasing moves are possible, we have arrived at the equilibrium combination 11 Dr. Mazharul Islam 9w/11/2013

13. Example Suppose that we have the following bits of information  The price of pizza per unit is $8  The rental price of a movie video is $4  After tax income equals $40 per week 12 Dr. Mazharul Islam 9w/11/2013

14. 13 Dr. Mazharul Islam 9w/11/2013 Total Marginal per Dollar Video Total Marginal per Dollar Consumed Utility utility Marginal utility Rentals Utility of utility of marginal Utility of Per Weekof Pizza of Pizza (price=$8) per Week Videos Videos (price=$4) (1) (2) (3) (4) (5) (6) (7) (8) 0 0 - - 0 0 - - 1 56 56 7 1 40 40 10 2 88 32 4 2 68 28 7 3 112 24 3 3 88 20 5 4 130 18 2 ¼ 4 100 12 3 5 142 12 1 ½ 5 108 8 2 6 150 8 1 6 114 6 1 ½ To get the process going, suppose you start off spending your entire budget of $40 on pizza  5 pizzas per week at a total utility of 142. If you give up one pizza, you free up enough money to rent 2 videos. Would total utility increase from this reallocation? You give up 12 units of utility – the marginal utility of the 5th unit of pizza, to get 68 units of utility from the first 2 videos  total utility increases from 142 to 198.

15. Now it’s over for today. Do you have any question? 14 Dr. Mazharul Islam 5w/9/2013