ECO 101: Introduction to Microeconomics Lecture 5 Chapter 18: Consumer Choice: Maximizing Utility and Behavioral Economics ECO 101: Introduction to Microeconomics Naveen Abedin

UTILITY Utility means satisfaction in economics. Artificial measure of utility is utils Total Utility is the total satisfaction one receives from consuming a particular quantity of a good. E.g first burger gives you 10 utils, the second burger gives you 8 utils and the third burger gives you 6 utils. Total utility from the consumption of 3 burgers is 10 + 8 + 6 = 24 utils. Naveen Abedin

UTILITY (cont.) Total Utility ≠ Marginal Utility Marginal utility is the additional utility gained from consuming an additional unit of good X. Marginal utility is the change in total utility divided by the change in quantity consumed of a good X. Naveen Abedin

Law of Diminishing Marginal Utility The law of diminishing marginal utility states that for a given time period, the marginal utility gained by consuming equal successive units of a good will decline as the amount consumed increases. By this principle, the number of utils I gain by consuming the first unit is greater than the number of utils I gained from consuming the second unit. Naveen Abedin

Law of Diminishing Marginal Utility (cont.) With each additional unit of burger that I consume, my marginal utility is getting smaller and smaller, but my total utility is increasing by summation. My total utility will always keep increasing as long as marginal utility is positive. Units of Burgers Marginal Utility (utils) Total Utility (utils) 1 10 2 8 18 3 6 24 4 28 Naveen Abedin

Law of Diminishing Marginal Utility (cont.) Units of Good X Total Utility (utils) Marginal Utility (utils) - 1 10 2 19 9 3 27 8 4 34 7 5 40 6 Naveen Abedin

Law of Diminishing Marginal Utility (cont.) Why is marginal utility diminishing? You initially have just one unit of Good X, where Good X can be used to satisfy a number of desires. With just one unit of Good X available to you, you first satisfy your most urgent desire Naveen Abedin

Millionaire vs. Pauper Suppose that a millionaire currently has $2 million. And a poor man has $1000. If you give each of them $1, who is going to have a higher marginal utility from that extra dollar? Utility is subjective: There is no way you can compare one person’s utility compared to someone else’s. When you make an attempt to compare marginal utilities of $1 between two people, you are making the mistake of doing an interpersonal utility comparison. Naveen Abedin

Consumer Equilibrium Individuals seek to maximize their utility Example: Consumer A spends her entire income on the consumption of 10 apples and 10 oranges per week. Poranges = $1 Papples = $1 MUoranges = 30 utils MUapples = 20 utils Downward sloping marginal utility curves for apples and oranges. Naveen Abedin

Consumer Equilibrium (cont.) Week 1 Week 2 Consumer A purchases more oranges and less apples the second week Naveen Abedin

Consumer Equilibrium (cont.) Consumer equilibrium occurs when the consumer has spent all income and the marginal utilities per dollar spent on each good purchased are equal where the letters A-Z represent all the goods a person can buy. Naveen Abedin

Marginal Utility and Law of Demand Initially: Price of oranges fall: To restore equilibrium, Consumer A buys more oranges: Naveen Abedin