1. Consumer Choice and Utility Maximization

2. The Law of Diminishing “ADDITIONAL” “SATISFACTION”

3. DEFINITIONS
Law of Diminishing Marginal utility: Added satisfaction declines as a consumer acquires additional units of a given product.
Utility = a measure of want satisfying power. Utility is personal and subjective.

4. DEFINITIONS
Total Utility: The total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service.
Marginal Utility: The extra satisfaction a consumer realizes from an additional unit of that product

5. 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.

6. 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?

7. 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?

8. 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?

9. 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

10. 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.

11. 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?

12. 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?

13. 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?

14. 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?

15. Utility Maximizing Rule
The consumer’s money should be spent so that the marginal utility per dollar of each goods equal each other.
MUx = MUy
Px Py
3 apples and 2 oranges
Assume apples cost $1 each and oranges cost $2 each. If the consumer has $7, identify the combination that maximizes utility.

16. Utility Maximizing Rule
The utility maximizing rule assumes that you always consume where MU/P for each product is equal 16

17. Utility Maximizing Rule
The utility maximizing rule assumes that you always consume where MU/P for each product is equal
b) Assume that the cross-price elasticity of demand between peanuts and bananas is positive. A widespread disease has destroyed the banana crop. What will happen to the equilibrium price and quantity of peanuts in the short run? Explain.
Equilibrium price and quantity will both increase. Peanuts and bananas are substitutes (they have a positive cross-elasticity), so an increase in the price of bananas will cause demand for peanuts to increase.

18. Utility Maximizing Rule
The utility maximizing rule assumes that you always consume where MU/P for each product is equal
Assume that the price of bananas increases.
Will the substitution effect increase, decrease, or have no effect on the quantity of bananas demanded?
(ii) What happens to Sasha's real income?
Decrease
Decrease