1 Consumption Theory Why Growth and maintenance of life process Comfort Satisfaction – utility Pleasure – utility Display-Advertise status or perception of status Emulation

2 Utility Theory and Individual Choice According to economists, our behavior is motivated by rational self interest. According to this theory, two things determine what people do: The pleasure people get from doing or consuming something The price of doing or consuming that something.

3 Utility and Consumption Total Utility Marginal Utility   Next unit   Change in total utility from next unit of consumption   Diminishing Marginal Utility   Time   More is less

4 Diminishing Marginal Utility. The principle of diminishing marginal utility – after some point, the marginal utility received from each additional unit of a good decreases with each additional unit consumed. As additional units are consumed, marginal utility decreases, but total utility continues to increase. When total utility is at a maximum, marginal utility is zero. Beyond this point, total utility decreases and marginal utility is negative

5 Marginal and Total Utility Number of pizza slices Total utility Marginal utility

6 Marginal and Total Utility Total utility Q Total utility Marginal utility Marginal utility Q

7 Maximizing Utility – relationship of utility to price MU/P  MU a /P a = MU b /P b  And so on for all goods Maximizing Utility How to get the most for your Money Consume another unit of a if: Consume another unit of b if:

8 A Numerical Example MU a /P a = MU b /P b MU a = 20 P a = 10 MU b = 50 P b = 50 MU a /P a = 20/10 2 MU b /P b = 50/ > 1 So buy more of good a

9 A Numerical Example -- continued MU a /P a = MU b /P b MU a = 10 P a = 10 MU b = 50 P b = 50 MU a /P a = 10/10 1 MU b /P b = 50/ = 1 So = nirvana But consuming more of a It’s marginal utility decreases

10 Consumer Surplus Q P S D Pe Qe Consumer Surplus

11 Getting MU a /P a = MU b /P b may be difficult to do How do we know what MU is for each good we buy Example – Alcohol   Beer   Wine   Liquor But then Reality Sets In