1. Total Utility and Marginal Utility

2. What is utility? Utility of a consumer is a measure of the satisfaction the consumer derives from consumption of goods and services Utility of a consumer is a measure of the satisfaction the consumer derives from consumption of goods and services Each individual’s utility depends on everything that a person consumes Each individual’s utility depends on everything that a person consumes Consumption bundle – is the collection of all the goods and services consumed by that individual Consumption bundle – is the collection of all the goods and services consumed by that individual

3. Utility and Consumption Consumption bundle – is the collection of all the goods and services consumed by that individual Consumption bundle – is the collection of all the goods and services consumed by that individual Utility function – gives the total utility generated by his or her consumption bundle Utility function – gives the total utility generated by his or her consumption bundle Remember….people must make choices and they usually base them on at least one rough attempt to decide which choice will given them greater satisfaction Remember….people must make choices and they usually base them on at least one rough attempt to decide which choice will given them greater satisfaction

4. Measuring Utility Measured in hypothetical units called utils Measured in hypothetical units called utils

5. Diminishing Marginal Utility What is marginal utility? What is marginal utility? – The change in total utility generated by consuming one additional unit of that good or service The marginal utility curve shows how marginal utility depends on the quantity of a good or service consumed The marginal utility curve shows how marginal utility depends on the quantity of a good or service consumed – The marginal utility curve is constructed by plotting points at the midpoint of the unit intervals

6. Diminishing Marginal Utility Slopes downward due to diminishing marginal utility—each additional clam gives Cassie less utility than the previous clam Slopes downward due to diminishing marginal utility—each additional clam gives Cassie less utility than the previous clam

7. Diminishing Marginal Utility Not all marginal utility curves eventually become negative Not all marginal utility curves eventually become negative Generally accepted that marginal utility curves do slope downward – consumption of most goods and services is subject to diminishing marginal utility Generally accepted that marginal utility curves do slope downward – consumption of most goods and services is subject to diminishing marginal utility

8. Diminishing Marginal Utility The principle of diminishing marginal utility says that each successive unit of a good or service consumed adds less to total utility than the previous unit The principle of diminishing marginal utility says that each successive unit of a good or service consumed adds less to total utility than the previous unit The more of a good or service you consume, the closer you are to being satisfied – reaching a point at which an additional unit of the good adds nothing to your satisfaction The more of a good or service you consume, the closer you are to being satisfied – reaching a point at which an additional unit of the good adds nothing to your satisfaction

9. Budget Constraints & Budget Lines The principle of diminishing marginal utility is able to explain why most people eventually reach a limit The principle of diminishing marginal utility is able to explain why most people eventually reach a limit It costs some additional resources to consume more of a good, and consumers must take that cost into account when making choices It costs some additional resources to consume more of a good, and consumers must take that cost into account when making choices The fundamental measure of a cost is opportunity cost The fundamental measure of a cost is opportunity cost The amount of money a consumer can spend is limited, a decision to consume more of a good is also a decision to come less of some other good The amount of money a consumer can spend is limited, a decision to consume more of a good is also a decision to come less of some other good

10. Budget Constraints & Budget Lines Sammy loves clams and potatoes but he has a weekly income of $20 and since, given his appetite, more of either good is better than less, he spends it all on clams and potatoes Sammy loves clams and potatoes but he has a weekly income of $20 and since, given his appetite, more of either good is better than less, he spends it all on clams and potatoes If clams cost $4 per pound and potatoes cost $2 per pound If clams cost $4 per pound and potatoes cost $2 per pound What are his possible choices???? What are his possible choices???? What are his limits???? What are his limits????

11. Budget Constraints & Budget Lines Whatever he chooses, we know that the cost of his consumption bundle can not exceed the amount of money that he has to spend Whatever he chooses, we know that the cost of his consumption bundle can not exceed the amount of money that he has to spend. Expenditure on clams + Expenditure on potatoes ≥ Total income

12. Budget Constraints & Budget Lines Consumers have limited income and this limits how much they can consume. Consumers have limited income and this limits how much they can consume. With the equation – a consumer might choose a consumption bundle that costs no more than his or her income With the equation – a consumer might choose a consumption bundle that costs no more than his or her income Budget Constraint – requires that the cost of a consumer’s consumption bundle be no more than the consumer’s income Budget Constraint – requires that the cost of a consumer’s consumption bundle be no more than the consumer’s income

13. Budget Constraints & Budget Lines Sammy’s consumption bundles are his consumption possibilities Sammy’s consumption bundles are his consumption possibilities The set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices The set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices Remember – whether or not a particular consumption bundle is included in a consumer’s consumption possibilities depends on the consumer’s income and the prices of goods and services Remember – whether or not a particular consumption bundle is included in a consumer’s consumption possibilities depends on the consumer’s income and the prices of goods and services

14. 102345 10 8 6 4 2 A B C D E F Affordable consumption bundles that cost all of Sammy's income Sammy’s Budget Line, BL Affordable consumptio n bundles Unaffordable consumption bundles Quantity of clams (pounds) Quantity of potatoes (pounds) A B C D E F Consumption bundle 0 1 2 3 4 5 Quantity of clams (pounds) 10 8 6 4 2 0 Quantity of potatoes (pounds) Sammy’s Consumption Possibilities Does Point C represent Sammy’s budget constraint? Expenditure on clams + Expenditure on potatoes ≥ Total income 6 pounds of potatoes x $2 per pound + 2 pounds of clams x $4 per pound $12 + $8 = $20

15. Budget Constraints & Budget Lines Budget line show the consumption bundles available to a consumer who spends all of his or her income Budget line show the consumption bundles available to a consumer who spends all of his or her income Sammy’s is downward sloping because he is consuming all of his income Sammy’s is downward sloping because he is consuming all of his income

16. Consumption Choice Sammy has a budget constraint which means he will consume a consumption bundle on the budget line – a choice to consume a given quantity of claims also determines his potato consumption Sammy has a budget constraint which means he will consume a consumption bundle on the budget line – a choice to consume a given quantity of claims also determines his potato consumption How do we find the consumption bundle that maximizes Sammy’s total utility? How do we find the consumption bundle that maximizes Sammy’s total utility? Finding his optimal consumption bundle!

17. Consumption Choice Sammy’s optimal consumption bundle is the consumption bundle that maximizes the consumer’s total utility given his or her budget constraint Sammy’s optimal consumption bundle is the consumption bundle that maximizes the consumer’s total utility given his or her budget constraint

18. The utility of Sammy’s choices is shown below. The more Sammy consumer of either good, the higher his utility is. The utility of Sammy’s choices is shown below. The more Sammy consumer of either good, the higher his utility is. Due to his limited budget, he has to make a trade-off Due to his limited budget, he has to make a trade-off

19. Consumption Choice The more pounds of clams he consumes, the fewer potatoes, etc. The more pounds of clams he consumes, the fewer potatoes, etc. He must choose a point on his budget line He must choose a point on his budget line

20. Sammy’s Budget and Total Utility Sammy’s total utility is the sum of the utility he gets from clams and the utility he gets from potatoes.

21. Quantity of potatoes (pounds) 543 2 10 10 8 6 4 2 A A B B C C D D E E BL Utility function F F 543 2 10 80 70 60 50 40 30 20 10 Quantity of clams (pounds) 02 46 810 (a)Sammy’s Budget Line (b) Sammy’s Utility Function The optimal consumption bundle… Quantity of clams (pounds) Quantity of potatoes (pounds) … maximizes total utility given the budget constraint Total utility (utils) Optimal Consumption Bundle Sammy’s total utility is maximized at bundle C, where he consumes 2 pounds of clams and 6 pounds of potatoes. This is Sammy’s optimal consumption bundle.

22. Total Utility and Marginal Utility Notes

23. What is utility? Utility of a consumer is a measure of the satisfaction the consumer derives from consumption of goods and services Utility of a consumer is a measure of the satisfaction the consumer derives from consumption of goods and services Each individual’s utility depends on everything that a person consumes Each individual’s utility depends on everything that a person consumes Consumption bundle – is the collection of all the goods and services consumed by that individual Consumption bundle – is the collection of all the goods and services consumed by that individual

24. Utility and Consumption Utility function – Utility function – Remember….people must make choices and they usually base them on at least one rough attempt to decide which choice will given them greater satisfaction Remember….people must make choices and they usually base them on at least one rough attempt to decide which choice will given them greater satisfaction

25. Measuring Utility

26. Diminishing Marginal Utility What is marginal utility? What is marginal utility? The marginal utility curve shows how marginal utility depends on the quantity of a good or service consumed The marginal utility curve shows how marginal utility depends on the quantity of a good or service consumed

27. Diminishing Marginal Utility

28. Not all marginal utility curves eventually become negative Not all marginal utility curves eventually become negative Generally accepted that marginal utility curves do slope downward – consumption of most goods and services is subject to diminishing marginal utility Generally accepted that marginal utility curves do slope downward – consumption of most goods and services is subject to diminishing marginal utility

29. Diminishing Marginal Utility The principle of diminishing marginal utility says The principle of diminishing marginal utility says The more of a good or service you consume, the closer you are to being satisfied – The more of a good or service you consume, the closer you are to being satisfied –

30. Budget Constraints & Budget Lines The principle of diminishing marginal utility is able to explain why most people eventually reach a limit The principle of diminishing marginal utility is able to explain why most people eventually reach a limit It costs some additional resources to consume more of a good, and consumers must take that cost into account when making choices It costs some additional resources to consume more of a good, and consumers must take that cost into account when making choices The fundamental measure of a cost is ____________________ The fundamental measure of a cost is ____________________ The amount of money a consumer can spend is limited, a decision to consume more of a good is also a decision to come less of some other good The amount of money a consumer can spend is limited, a decision to consume more of a good is also a decision to come less of some other good

31. Budget Constraints & Budget Lines Sammy loves clams and potatoes but he has a weekly income of $20 and since, given his appetite, more of either good is better than less, he spends it all on clams and potatoes Sammy loves clams and potatoes but he has a weekly income of $20 and since, given his appetite, more of either good is better than less, he spends it all on clams and potatoes If clams cost $4 per pound and potatoes cost $2 per pound If clams cost $4 per pound and potatoes cost $2 per pound What are his possible choices???? What are his possible choices???? What are his limits???? What are his limits????

32. Budget Constraints & Budget Lines Whatever he chooses, we know that the cost of his consumption bundle can not exceed the amount of money that he has to spend Whatever he chooses, we know that the cost of his consumption bundle can not exceed the amount of money that he has to spend.

33. Budget Constraints & Budget Lines Consumers have limited income and this limits how much they can consume. Consumers have limited income and this limits how much they can consume. With the equation – a consumer might choose a consumption bundle that costs no more than his or her income With the equation – a consumer might choose a consumption bundle that costs no more than his or her income Budget Constraint – Budget Constraint –

34. Budget Constraints & Budget Lines Sammy’s consumption bundles are his consumption possibilities Sammy’s consumption bundles are his consumption possibilities The set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices The set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices Remember – Remember –

35. 102345 10 8 6 4 2 A B C D E F Affordable consumption bundles that cost all of Sammy's income Sammy’s Budget Line, BL Affordable consumptio n bundles Unaffordable consumption bundles Quantity of clams (pounds) Quantity of potatoes (pounds) A B C D E F Consumption bundle 0 1 2 3 4 5 Quantity of clams (pounds) 10 8 6 4 2 0 Quantity of potatoes (pounds) Sammy’s Consumption Possibilities

36. Budget Constraints & Budget Lines Budget line show the consumption bundles available to a consumer who spends all of his or her income Budget line show the consumption bundles available to a consumer who spends all of his or her income Sammy’s is downward sloping because Sammy’s is downward sloping because

37. Consumption Choice Sammy has a budget constraint which means he will consume a consumption bundle on the budget line – a choice to consume a given quantity of claims also determines his potato consumption Sammy has a budget constraint which means he will consume a consumption bundle on the budget line – a choice to consume a given quantity of claims also determines his potato consumption How do we find the consumption bundle that maximizes Sammy’s total utility? How do we find the consumption bundle that maximizes Sammy’s total utility?

38. Consumption Choice

39. The utility of Sammy’s choices is shown below. The more Sammy consumer of either good, the higher his utility is. The utility of Sammy’s choices is shown below. The more Sammy consumer of either good, the higher his utility is. Due to his limited budget, Due to his limited budget,

40. Consumption Choice The more pounds of clams he consumes, the fewer potatoes, etc. The more pounds of clams he consumes, the fewer potatoes, etc. He must choose a point on his budget line He must choose a point on his budget line

41. Sammy’s Budget and Total Utility

42. Quantity of potatoes (pounds) 543 2 10 10 8 6 4 2 A A B B C C D D E E BL Utility function F F 543 2 10 80 70 60 50 40 30 20 10 Quantity of clams (pounds) 02 46 810 (a)Sammy’s Budget Line (b) Sammy’s Utility Function Quantity of clams (pounds) Quantity of potatoes (pounds) Total utility (utils) Optimal Consumption Bundle