1 Utility and Consumer Preferences Utility is the word used in economics to represent the happiness or satisfaction people get from the activities in which they participate.

2 Utility Utility refers to the happiness or satisfaction we get from consuming items. We will use numbers to express how much utility we get from consuming products. The main point is: the higher the number, the more utility we have. Another way to say this is if we give a higher number to one option than another option, then the higher numbered option has more utility, or is said to be the preferred option. Utility represents preference.

3 Example for a person

4 Example continued On the previous screen I have a table of numbers presented. The numbers inside the table represent the utility the person has from consuming a certain “basket” or “bundle” of goods. For example, 1 lb of bananas and 3 lbs of grapes yields total utility of 23 for this person. Note: a different person is likely to have a different set of numbers in the table. Note: any basket can be compared to any other basket. Basket A is either preferred to basket B, is less preferred to B, or leaves an individual indifferent to B (has same utility as B.)

5 Marginal utility Start at 1 lb of each item. Total utility is 16. If you go up the column – that is, have one lb of bananas and increase lbs of grapes – you see the numbers grow. Having more grapes make this person happier. But notice the increase in utility per increase in lbs of grapes, assuming only 1 lb of bananas. The second lb of grapes adds 4 units of utility. What does the 3 rd lb of grapes add? The additional utility from an additional pound of grapes (while holding bananas constant) is called the marginal utility of grapes. The marginal utility diminishes here, doesn’t it? What is happening with bananas, holding an amount of grapes fixed?

6 Utility maximization People act in their own rational self-interest. Another way to say this is that people make purposeful choices. In the context of the consumer we say this self interest shows up in the idea that consumers try to maximize their utility. There is a complicating feature: consumers have to pay prices and only have so much income. Some baskets are not able to be purchased. This feature is called the budget constraint. We turn to that next.