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Today

Learn how consumers aim to maximize utility within budget constraints, illustrating diminishing marginal utility with pizza slices and consumer surplus concepts.

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Today

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  1. Today • Utility • Diminishing Marginal Utility • How to Max. Utility • Consumer’s Surplus • Read Chapter 19, skip appendix .

  2. Where does a household’s demand curve come from?

  3. Consumer Choice • Utility: An abstract concept used to describe well-being or satisfaction. • Consumer’s Goal: to maximize utility, subject to available income.

  4. A Simple Approach • Assume utility can be quantified. • A person can measure his utility. • Each person’s “scale” is different. • As consumption increases, total utility increases.

  5. Diminishing Marginal Utility • Marginal Utility: The additional utility one gets from consuming one more unit of a good. • We assume consumers get diminishing marginal utility as their consumption of a good increases.

  6. Example: Eating Pizza • The second slice of pizza doesn’t increase your utility as much as the first one did. Units of utility/slice 1 2 3 4 Slices/day 5

  7. Your MU in $ Spent on Pizza • Now measure a unit of utility in dollar terms. • The vertical scale changes, but $/slice still goes down for each unit. Value in $/slice $5 4 3 2 1 1 2 3 slices/day 4

  8. Your Demand Curve for Pizza • The height of an individual’s demand curve represents the most he is willing to pay to get each successive slice of pizza. Value in $/slice $5 4 3 2 1 1 2 3 D 4 slices/day

  9. Total Value to Consumer • The area under a demand curve represents the total value to the consumer of consuming a particular Q of a good.

  10. Total Valuation • This consumer is willing to pay $9 for one unit. • Or $42 for 7 units. $/unit 8 6 4 2 D 1 3 4 5 2 6 7 units

  11. Utility Maximization • The consumer maximizes utility by consuming until his marginal valuation is equal to the price. • If P=$6, he buys 4 units. • 4 units are worth $30 to him. $/unit 8 6 4 2 D units 1 3 4 5 2 6 7

  12. Utility Maximization • The 3rd unit is worth $7 to him, costs only $6. Can increase utility by buying more. • The 4th unit is worth exactly $6 to him. Assume he goes ahead. • The 5th unit is worth $5, but costs $6. Stop at 4 units.

  13. Consumer’s Surplus • The 4 units cost him 4@$6 = $24. • They are worth $30 to him. • The difference is called his “consumer’s surplus”.

  14. Consumer’s Surplus • Consumer’s Surplus: the difference between how much a consumer values a good and how much he pays for it.

  15. Graph of CS • CS = $6 when the price is $6. • No CS is earned on the 4th unit. • CS is the area under D and above P. $/unit 8 6 4 2 D units 1 3 4 5 2 6 7

  16. Smooth Graph of CS • A+B = the value to the consumer from 4 units. • B = what the consumer pays for those 4 units • A = Consumer’s surplus from the 4 units. $/unit 8 A 6 B 4 D 2 units 1 3 4 5 2 6 7

  17. Coming Up • Application of consumer’s surplus. • Getting a market demand curve from individual demand curves.

  18. Now • Go over exams.

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