Consumer Choice and Utility Maximization

The Law of Diminishing “ADDITIONAL” “SATISFACTION”

Would you see the movie three times? Thinking at the Margin # Times Watching Movie Marginal Utility Price 1st $30 $10 2nd $15 3rd $5 Total $50 Would you see the movie three times? Notice that the total benefit is more than the total cost but you would NOT watch the movie the 3rd time.

Calculate Marginal Utility # of Slices of Pizza Total Utility (in utils) Marginal Utility/Benefit 1 8 2 14 3 19 4 23 5 25 6 26 7 24 How many pizzas would you buy if the price per slice was $2?

Calculate Marginal Utility # of Slices of Pizza Total Utility (in dollars) Marginal Utility/Benefit 1 8 2 14 6 3 19 5 4 23 25 26 7 24 -2 Marginal Cost $2 How many pizzas would you buy if the price per slice was $2?

Calculate Marginal Utility # of Slices of Pizza Total Utility (in dollars) Marginal Utility/Benefit 1 8 2 14 6 3 19 5 4 23 25 26 7 24 -2 Marginal Cost 2 You will continue to consume until Marginal Benefit = Marginal Cost How many pizzas would you buy if the price per slice was $2?

Marginal Utility Per Dollar CONSUMER BEHAVIOR You plan to take a vacation and want to maximize your utility. Based on the info below, which should you choose? Destination Marginal Utility (In Utils) Price Tahiti 3000 $3,000 Chicago 1000 $500 Marginal Utility Per Dollar 1 Util 2 Utils

Marginal Utility Per Dollar CONSUMER BEHAVIOR You plan to take a vacation and want to maximize your utility. Based on the info below, which should you choose? Destination Marginal Utility (In Utils) Price Tahiti 3000 $3,000 Chicago 1000 $500 Marginal Utility Per Dollar 1 Util 2 Utils Calculating Marginal Utility Per Dollar allows you to compare products with different prices.

Utility Maximization $10 $5 # Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 10 2nd 20 5 3rd 2 4th 1 If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization $10 $5 # Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 3 10 $2 2nd 20 5 $1 3rd 2 $.40 4th $.50 1 $.20 If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization $10 $5 # Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 3 10 2 2nd 20 $2 5 $1 3rd $.40 4th $.50 1 $.20 If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization $10 $5 # Times Going Marginal Utility (Movies) MU/P (Price =$10) Marginal Utility (Go Carts) (Price =$5) 1st 30 3 10 2 2nd 20 5 1 3rd .40 4th .50 .20 If you only have $25, what combination of movies and go carts maximizes your utility?

Production= Converting inputs into output Widget Production Simulation Production= Converting inputs into output

Analyzing Production Lets look at an example to show the relationship between inputs and outputs

Production Simulation Overview The class will be divided into two firms. There will be several rounds in which each firm will produce chains out of paper. Each round last exactly 2 minutes Each firm is going to hire one more worker at the start of each round. Resources 1 stapler, 1 scissors, 1 table, and plenty of staples and paper Rules Workers cannot stockpile slips of paper. No extras Workers cannot cut more than one paper at a time Workers can only add links to one side of the chain Each link must pass inspection If links don’t meet specifications they won’t count Responsibilities The manager will hire the workers. The inspector will check to make sure each product is made to specifications

Production Simulation Step 1: Cut paper down the middle into two piece Step 2: Fold piece down the middle Step 3: Wrap ends around and staple Step 4: Add more links to one end

Production Simulation Complete the chart for your firm: Number of Workers (inputs) Total Product (output) Marginal Product 1 2 3 4 5 6

Simulation Debrief Key Questions: What happened to the number on links produced as more workers were hired? Why can the second worker generate more additional links than one worker working alone? Why did the additional output for each worker eventually start to fall or even go negative? What would happen to total output if every student in the room tried to make links given the limited resources?

Simulation Debrief Fixed Resources- Resources that DON’T change with the amount produced Ex: Stapler, scissors, and table Variable Resources- Resources that DO change as more or less is produced Ex: Workers, paper, and staples

Simulation Debrief Total Physical Product (TP)- total output or quantity produced Marginal Product (MP)- the additional output generated by additional inputs (workers). Marginal Product = Change in Total Product Change in Inputs Average Product (AP)- the output per unit of input Average Product = Total Product Units of Labor

The Law of Diminishing Marginal Returns Too many cooks in the kitchen! Production Analysis What happens to the Total Product as you hire more workers? What happens to marginal product as you hire more workers? Why does this happens? The Law of Diminishing Marginal Returns As variable resources (workers) are added to fixed resources (machinery, tool, etc.), the additional output produced from each new worker will eventually fall. Too many cooks in the kitchen!