CHAPTERS 8 Utility and Demand

1. CHAPTERS8Utility and Demand

2. Marginal Utility Theory • The purpose of marginal utility theory is to explain an individual household’s demand. • Marginal utility theory predicts that individual demand curves slope downward. • Therefore, market demand curves must also slope downward.

3. Household Consumption Choices • Two factors determine a household’s consumption choices: • Its budget constraint (how much money it has to spend and the prices of each good or service it buys) • Its preferences (how much it likes each good relative to others)

4. Budget Constraint • A household’s consumption choices are constrained by its income and by the prices of the goods and services it buys. • The limits to a household’s consumption choices are described by its budget constraint or sometimes called its budget line.

5. Example - Lisa’s Consumption Possibilities • Lisa has $30 per month to spend on movies and soda. • Movies cost $6 each. If she spends her entire budget on movies, she can see 5 per month. • Soda costs $3 per six-pack. If she spends her entire budget on soda, she can drink 10 six-packs a month.

6. Consumption Possibilities Movies ($6) Soda ($3) Expenditure Expenditure Possibility Q (dollars) Q (dollars) a 0 0 10 30 b 1 6 8 24 c 2 12 6 18 d 3 18 4 12 e 4 24 2 6 f 5 30 0 0

7. Consumption Possibilities a 10 b 8 c Soda (six-packs per month) 6 d 4 e 2 f Movies (per month) 0 1 2 3 4 5

8. Consumption Possibilities a 10 b Each point on line exhausts the entire $30 budget 8 c Soda (six-packs per month) 6 d 4 e 2 f Movies (per month) 0 1 2 3 4 5

9. Consumption Possibilities a 10 Affordable b 8 Unaffordable c Soda (six-packs per month) 6 d 4 e 2 f Movies (per month) 0 1 2 3 4 5

10. Preferences • The combination of goods and services a person chooses to consume from the available choices on the budget line is determined by their likes and dislikes — their preferences. • The satisfaction a person gets from consumption is called utility.

11. Lisa’s Preferences • How Lisa spends her $30 per month depends on her preferences for movies and soda. • Each additional movie or soda she consumes increases her total utility.

12. Utility Is an Abstract Concept • We cannot directly observe values for utility. • However, each of us knows what we like and what we dislike. • We will consume more of the goods and services we like and less of those we dislike.

13. Total Utility • Total utility is the total benefit or satisfaction that a person gets from the consumption of goods and services. • Total utility depends on the level of consumption — more consumption generally increases total utility.

14. Lisa’s Total Utility • The more movies Lisa sees each month, the greater her total utility from movies. • The more soda Lisa drinks each month, the greater her total utility from soda.

15. Marginal Utility • Marginal utility is the change in total utility resulting from a one-unit increase in the quantity of a good consumed.

16. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

17. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

18. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

19. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

20. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

21. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 25 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

22. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 25 21 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

23. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 25 21 18 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

24. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 25 21 18 15 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

25. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 25 21 18 15 12 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

26. Total Utility and Marginal Utility Movies Quantity Total utility Marginal utility - 50 38 33 29 25 21 18 15 12 9 0 0 1 50 2 88 3 121 4 150 5 175 6 196 7 214 8 229 9 241 10 250

27. Diminishing Marginal Utility • As consumption of a good or service increases, the incremental(or marginal) satisfaction we get from consuming one more unit decreases. • This decrease is called the principle of diminishing marginal utility.

28. Total Utility and Marginal Utility 200 Units of utility Units of utility 150 100 50 50 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

29. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 50 50 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

30. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 Increasing total utility... 50 50 50 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

31. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 Increasing total utility... …and diminishing marginal utility 50 50 50 38 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

32. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 Increasing total utility... …and diminishing marginal utility 50 50 50 38 33 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

33. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 Increasing total utility... …and diminishing marginal utility 50 50 50 38 33 29 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

34. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 Increasing total utility... …and diminishing marginal utility 50 50 50 38 33 29 25 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

35. Total Utility and Marginal Utility 200 Total utility Units of utility Units of utility 150 100 Increasing total utility... …and diminishing marginal utility 50 50 Marginal utility 50 38 33 29 25 0 1 2 3 4 5 0 1 2 3 4 5 Quantity (movies per month) Quantity (movies per month)

36. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

37. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

38. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

39. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

40. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

41. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 25 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

42. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 25 19 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

43. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 25 19 18 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

44. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 25 19 18 17 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

45. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 25 19 18 17 16 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

46. Total Utility and Marginal Utility Soda Quantity Total utility Marginal utility - 75 42 36 28 25 19 18 17 16 15 0 0 1 75 2 117 3 153 4 181 5 206 6 225 7 243 8 260 9 276 10 291

47. Maximizing Utility • A household’s income and the prices it faces limit the total utility it can obtain. • We assume that households consume the quantities of goods and services that maximize total utility. • People must make hard choices because wants exceed resources.

48. The Utility-maximizing Choice • A consumer equilibrium is a situation in which a consumer has allocated his or her income in the way that, given the prices of goods and services, maximizes his or her total utility.

49. Lisa's Affordable Combinations Movies Soda Total utility Quantity from movies Six-packs per month Total utility and soda Total utility per month a 0 0 291 10 b 1 50 260 8 c 2 88 225 6 d 3 121 181 4 e 4 150 117 2 f 5 175 0 0

50. Lisa's Affordable Combinations Movies Soda Total utility Quantity from movies Six-packs per month Total utility and soda Total utility per month a 0 0 291 291 10 b 1 50 260 8 c 2 88 225 6 d 3 121 181 4 e 4 150 117 2 f 5 175 0 0