MARGINAL UTILITY In relation to consumers!!!!!!

MARGINAL UTILITY Marginal = Extra Utility = Satisfaction

DIMINISHING MARGINAL UTILITY Lets test: If a consumer consumes 1 extra unit (marginal) of a good or service in succession what happens to their utility (satisfaction) after the consumption of that good.

Yum 10 out of 10 Ok 8 out of 10 Ghosty 6 out of 10 Yum 10 out of 10

DEFINING MARGINAL UTILITY As additional units of a G or S are consumed (consecutively) Total Utility increases at a decreasing rate. Or As additional units of a G or S are consumed (consecutively) Marginal Utility decreases. LAW OF MARGINAL UTILITY

CRITERIA LI: Understand and apply the Law of Diminishing Marginal Utility

REVISIT Yum 10 out of 10 Ok 8 out of 10 Ghosty 6 out of 10 Yum 10 out of 10

LAW OF MARGINAL UTILITY As additional units of a G or S are consumed (consecutively) Total Utility increases at a decreasing rate. Or As additional units of a G or S are consumed (consecutively) Marginal Utility decreases.

THE OPTIMUM PURCHASE RULE P = MU Consumers will/should continue to consume up to where Price is equal to Marginal Utility (P = MU) as they will maximise their total utility.

P = MU P falls to P¹ P¹ ≠ MU (P¹ < MU) Incentive to consume more MU falls P¹ = MU Therefore a demand curve is drawn downward sloping to the right (i.e. as price falls, quantity demanded will increase) THE OPTIMUM PURCHASE RULE P = MU

P = MU P rises to P¹ P¹ ≠ MU (P¹ > MU) Incentive to consume less MU rises P¹ = MU Therefore a demand curve is drawn downward sloping to the right (i.e. as price rises, quantity demanded will fall)

A rational consumer will consume successive units of a good until they reach the point where P = MU. At this point the price that they are paying for the additional unit matches the marginal utility that they are receiving. If P < MU then the consumer has an incentive to consume more because they are ‘getting a bargain’ (i.e. receiving more marginal utility than they are paying for) If P > MU then the consumer has an incentive to consume less because they are ‘getting ripped off’ ( i.e. receiving less marginal utility than they are paying for) THE OPTIMUM PURCHASE RULE P = MU

TABLE 1 Angela Agassi’s Utility Schedule for Tennis Balls Quantity Consumed (packs of three) Total utility ($) Marginal utility ($) Price ($)Quantity (3- packs) Demand schedule for Ang Agassi 1.Fill in the missing gaps for Table 1 2.Complete the demand schedule for Ang Agassi 3.Graph Ang Agassi’s Demand Curve. 4.Explain why the demand curve slopes downward.

ANSWERS TABLE 1 Angela Agassi’s Utility Schedule for Tennis Balls Quantity Consumed (packs of three) Total utility ($) Marginal utility ($) Price ($)Quantity (3- packs) Demand schedule for Ang Agassi

4. If Angela is a rational consumer she will purchase packs of tennis balls, until she reaches the point where P=MU (optimal purchase rule). When the price of tennis balls falls, P<MU. Because P<MU, there is an incentive for Angela to increase her consumption of tennis balls. As she consumes additional units, MU will fall. Therefore a demand curve is drawn downward sloping to the right (i.e. as price falls, quantity demanded will increase)

CRITERIA LI: Understand and apply the Law of Diminishing Marginal Utility. Use the Law of Diminishing Marginal Utility to describe the demand curve Use Equal marginal rule to calculate the optimum amount of a good or service a consumer should consume to maximise his/her utility

QUIZ (a)Define marginal utility. Quantity Purchas ed Total Utility Marginal Utility (cents) (d)Use the law of diminishing marginal utility to explain why Sam’s demand curve for DVDs will slope downward to the right. Price ($) Quantity (DVD’S)

ANSWERS Quantity Purchas ed Total Utility Marginal Utility (cents) Price ($) Quantity (DVD’S) The law of diminishing marginal utility states that as more of a good or service is consumed successively marginal utility falls. A rational consumer will only increase consumption if P=MU. As consumption increases from 1 to 2 goods MU falls from 750 to 600. The consumer will only purchase additional units if the price is lowered to where P=MU. Therefore a demand curve is drawn downward sloping to the right As additional units of a G or S are consumed (consecutively) Total Utility increases at a decreasing rate. Or As additional units of a G or S are consumed (consecutively) Marginal Utility decreases.

THE LAW OF EQUAL MARGINAL UTILITY AND CONSUMER EQUILIBRIUM How can a consumer maximise his Utility on the next dollar spent. What combination of goods/service is going to give the highest amount of utility. INFORMATION WE HAVE: Budget (fixed amount of money) MU of both goods Price of both goods

EXAMPLE QuantityMUxMUa/PaMUyMUb/Pb Price of burgers ($5)Price of chips ($2) Formula Equi marginal rule If Jimbo had $11 to spend, what combination of chips and burgers he should buy to maximise his utility. QuantityMUxMUa/PaMUyMUb/Pb Price of burgers ($5)Price of chips ($2)

QUICK QUIZ Jack and Jill both earn $10 pocket money. They spend all $10 on chips and lollies. Jill purchases six packets of chips and two packets of lollies. Use table 1 to determine the quantity of chips and lollies Jack should purchase to maximise his total utility. A packet of chips costs $1 and a packet of lollies costs $2. Quantity of chips (packet) Marginal utility (utils) MUa/MUb chips Quantity of lollies (packet) Marginal utility (utils) MUa/MUb lollies

ANSWER Quantity of chips (packet) Marginal utility (utils) MUa/Pa chips Quantity of lollies (packet) Marginal utility (utils) MUa/Pa lollies packets of chips 3 packets of lollies