Unit 3: Utility Ap Micro 9/27

Warm Up What is marginal utility? What is utility for that matter? Use the concept of marginal utility to explain the following: Newspaper vending machines are designed so that once you have paid for one paper, you can take more than one paper at a time. But soda vending machines, once you have paid for one soda, dispense only one soda at a time. Why?

Utility and Consumption Utility: satisfaction gained from consumption Not the same as usefulness Subjective and difficult to quantify Utils = units of utility Consumption bundle: set of all goods and services a person consumes Utility function: relationship between consumption bundle and total utility generated

Law of Diminishing Marginal Utility Marginal utility: the change in total utility from consuming one more unit Diminishing Marginal Utility: Additional satisfaction declines as a consumer acquires additional units of a given product

Total Utility and Marginal Utility Total utility (utils) (a) Cassie’s Utility Function 70 15 13 11 9 7 5 3 1 –1 28 39 48 55 60 63 64 Total utility (utils) Marginal utility per clam (utils) 2 4 6 8 Quantity of clams 60 Utility function 50 40 30 20 10 1 2 3 4 5 6 7 8 9 Quantity of clams Marginal utility per clams (utils) ( b ) Cassie’s Marginal Utility Curve Figure Caption: Figure 10-1: Cassie’s Total Utility and Marginal Utility Panel (a) shows how Cassie’s total utility depends on her consumption of fried clams. It increases until it reaches its maximum utility level of 64 utils at 8 clams consumed and decreases after that. Marginal utility is calculated in the table. Panel (b) shows the marginal utility curve, which slopes down- ward due to diminishing marginal utility. That is, each additional clam gives Cassie less utility than the previous clam. 16 14 12 10 8 Marginal Utility Curve 6 4 2 –2 1 2 3 4 5 6 7 8 9 Quantity of clams

Practice Problems Explain why a rational consumer who has diminishing marginal utility for a good would not consume an additional unit when it generates negative marginal utility, even when that unit is free. What might be an example of this? Marta drinks 3 cups of coffee a day, for which she has diminishing marginal utility. Which of her 3 cups generates the greatest increase in total utility? Which generates the least? In each of the following cases, does the consumer has diminishing, constant, or increasing marginal utility? The more Mabel exercises, the more she enjoys each additional visit to the gym. Although Mei’s CD collection is huge, her enjoyment from buying another CD has not changed as her collection has grown. When Dexter was a struggling student, his enjoyment of a good restaurant meal was greater than now, when he has them more frequently.

Marginal Utility and Demand The law of diminishing marginal utility explains the downward slope of the demand curve Supports the idea that price must decrease in order for quantity demanded to increase

Theory of Consumer Behavior Law of diminishing marginal utility helps explain how consumers allocate their money The situation for the typical consumer has the following dimensions: Rational behavior: Consumers use their income to maximize their utility Preferences: Each consumer has preferences for specific goods and know how much MU they will gain from successive units

Theory of Consumer Behavior The situation for the typical consumer has the following dimensions: Budget constraint: Every consumer has a fixed, limited amount of money income Prices: Prices reflect scarcity. Assume that the price of a good is unaffected by the amount of it that is bought by any particular person

Budgets Consumption possibilities: set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices Budget line: all of the consumption bundles available to a consumer who spends all of his/her income

Budget Line Sammy’s income = $20/week Potatoes = $2/lb; clams = $4/lb Quantity of potatoes (pounds) A B C D E F Consumption bundle 1 2 3 4 5 Quantity of clams (pounds) 10 8 6 Quantity of potatoes Unaffordable consumption bundles 10 A 8 B 6 C Affordable consumption bundles that cost all of Sammy's income 4 Affordable consumption bundles D 2 E F Sammy’s Budget Line, BL 1 2 3 4 5 Quantity of clams (pounds) The budget line represents all the possible combinations of quantities of potatoes and clams that Sammy can purchase if he spends all of his income. It is also the boundary between the set of affordable consumption bundles (the consumption possibilities) and unaffordable ones.

Budget Constraints Budget constraints aren’t just about money. In fact, there are many other budget constraints affecting our lives. Examples are: Limited amount of closet space for clothes. A fixed number of hours in a day. A dieter on the Weight Watchers plan is only allowed a maximum number of points regarding the food they can eat each day whereby each food is assigned a certain number of points. (The dieter is just like a consumer choosing a consumption bundle: points are the equivalent of prices, and the overall point limit is the equivalent of total income.)