Transcript utils

Consumer Choice
Utility maximization
Do you shop incessantly?
Did you ever have buyer’s remorse?






What makes you happy with a purchase?
Do you consider yourself rational
How do you define rational?
Do you look at the marginal utility?
What is diminishing marginal utility?
What about MC = MB?
What is total utility?
Total utility= amount of satisfaction obtained
from entire consumption of a product.
Willing to stay through all three acts of Le’
Miserable– great till the very last curtain call.
16 oz steak good to last bite.
Watching 4 OT’s in a Hockey playoff.
Utility Theory
•
The more pleasure (satisfaction, utility) we get
from a product, the higher the price we’re willing
to pay for it.
–
–
–
Utility: the pleasure or satisfaction obtained from
using a good or service.
Total utility: the amount of satisfaction obtained from
the consumption of a series of products.
Marginal utility: the change in total utility obtained
by consuming one additional (marginal) unit of a
product.
19-4
Total and Marginal Utility of Downloading
and Listening to Digital Music Albums, Panel
(a)
TU and MU
As more of a product is
consumed, Total utility
increases at a
Diminishing rate.
Tacos
consumed
in 1 meal
TU
MU
0
1
0
10
10
2
18
8
3
24
6
4
28
4
5
30
2
6
30
0
7
28
-2
TOTAL AND MARGINAL UTILITY
0
10
18
24
28
30
30
28
10
8
6
4
2
0
-2
30
Total Utility (utils)
0
1
2
3
4
5
6
7
TU
20
10
0
Marginal Utility (utils)
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
2
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
0
10
18
24
28
30
30
28
10
8
6
4
2
0
-2
30
Total Utility (utils)
0
1
2
3
4
5
6
7
TU
20
10
0
Marginal Utility (utils)
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
Observe
Diminishing
Marginal
Utility
1
2
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
7
Units consumed per meal
Utility Theory (cont'd)

Observations

Marginal utility falls as more is consumed.

Marginal utility equals zero when total utility is at
its maximum.
Diminishing Marginal Utility
As long as marginal utility > 0, total utility increases. When marginal
utility becomes negative, total utility maxes out and then decreases.
19-10
Diminishing Marginal Utility

Law of Diminishing Marginal Utility = the
marginal utility of a good declines as more of
it is consumed in a given period of time.

As long as MU is increasing TU must be
increasing.
When MU is not increasing (diminishing)
each unit added yields less utility

Example: Newspaper Vending Machines
versus Candy Vending Machines

Newspaper machines do not prevent people from
taking more than one paper. Why not dispense candy
the same way?

The answer is found in the concept of diminishing
marginal utility.

Can you think of a circumstance under which a
substantial number of newspaper purchasers might
be inclined to take more than one newspaper from a
vending machine?

Consumer Optimum – Consumer
Equilibrium

A choice of a set of goods and services that maximizes the
level of satisfaction for each consumer, subject to limited
income

Utility maximization – consumers want to get the most
satisfaction from consumption choices

Need to look at the concept of

Marginal Utility per dollar spent
Optimizing Consumption Choices
Consumer Equilibrium





A consumer’s money income should be allocated so that the
last dollar spent on each good purchased yields
the same amount of marginal utility
(when all income is spent),
because this rule yields the largest possible total utility
Optimizing Consumption Choices
Consumer Equilibrium

A little math
 The rule of equal marginal utilities per dollar
spent
MU of good A
MU of good B
=
Price of good A
MU of good Z
...=
Price of good B
Price of good Z
Optimizing Consumption Choices
Consumer Equilibrium

A little math

The rule of equal marginal utilities per dollar
spent

A consumer maximizes personal satisfaction when
allocating money income in such a way that the last
dollars spent on good A, good B, good C, and so on,
yield equal amounts of marginal utility
Total and Marginal Utility from Consuming
Music Album Downloads ($5) and
Cappuccinos ($3) on an Income of $26
Total and Marginal Utility from Consuming
Music Album Downloads and Cappuccinos
on an Income of $26
Steps to Consumer
Equilibrium
Price and Quantity



The demand curve
slopes downward
because of diminishing
marginal utility.
In order to justify
buying more, the price
must be lower.
At $0.25, the consumer
buys 12 ounces (point
f).
19-20
Maximizing Utility
How would you maximize your utility?
Select that good which delivers the most
marginal utility/dollar even for last dollar
spent. (allocation of dollars example)
Buying that new IPhone 5 is “worth it” even
though it cost $500.00?
Why would we buy it if it doesn’t bring some
degree of satisfaction?
Let’s think of MU as MB
Remember… If MC > MB should not produce.
Criminal behavior – person stealing imposes
uncompensated costs on others
Person considering not stealing, but buying
weighs the cost (price) and benefit (utility.)
How could we reduce criminal activity to not
create cost to society?
Theory of Consumer Behavior





Theory of Rational Behavior
Preferences
Budget Constraints
Prices
Time (Time/value/money)


Total utility versus marginal utility

Total utility is total satisfaction from
consumption.

Marginal utility is the additional satisfaction from
consuming an additional unit.
Law of diminishing marginal utility

Marginal utility ultimately declines as a person
consumes more and more of a good or service.
The consumer optimum

Occurs when the marginal utility per dollar spent
on the last unit consumed is equalized
The substitution effect of a price change

A person will substitute among goods by buying
less of a good when its price increases.
Practice Set
Cups of Coffee
TC
TB
1x 30=.30
2x 30 =.60
3x 30 =.90
4x 30 =1.20
5x30 = 1.50
6
7
$3.00
$2.00
$1.00
$0.50
$0.10
$0.05
$0.00
MC
$.30
.30
.30
.30
Coffee costs $.30/cup..If you behave according to consumer choice and
In rational manner.. How many cups will you drink?
Time/Value/Money
Assuming you want to derive total satisfaction for last
dollar spent.
Golf Outing = $30.00
Concert = $40.00
Both are equal in utility to you.
Which would actually be more costly to indulge in?
Golf takes 4 hours
Concert approximately 2 hours
Other Important Info for Rational Utility
Maximization Decision to be made




How much do you make an hour?
If you earn $10.00 an hour, golf game costs your
$70.00… concert $60.00
How did you get this sum?
(Golf = $30.00 Market place + $40.00 )
(Concert = $40.00 Market place + 20.00)
Now you know in economic terms why driving all over Dallas to
pick up “loss leaders” is costly.
TIME IS MONEY!
Time/Value/Money

Does the doctor run around
doing errands in search of
bargains?

Does the CEO do his own
typing?
Remember.. Substitution
We have learned:




That maximizing our utility is our goal.
That our marginal utility decreases with each
additional unit.
That because of this the demand curve will be
downward sloping
We can also shift our demand curve to a
substitute (assuming we can get equal utils of
satisfaction.)
Last check on knowledge!
Units
Consumed
TU
0
1
2
3
4
5
6
0
10
MU
10
8
25
30
3
34
Units
Consumed
TU
MU
0
1
2
3
4
5
6
0
10
18
25
30
33
34
10
8
7
5
3
1
Kiley- Total Utility- Never diminishing