Econ Chapter 20
Marginal Utility
MU=change in total utility/change in # of units consumed
What is marginal utility? Why is the term "marginal" important in utility analysis?
Marginal utility is the change in total utility due to a one-unit change in the quantity of a good consumed. Marginal means addition or incremental. "Marginal" is important in utility analysis because an individual contemplating increasing consumption of an item by one additional unit compares the utility gain from that one additional unit consumer per dollar spent with the additional utility per dollar spent on all other items.
In a restaurant we can observe people consuming coffee, tea, and soft drinks. All are priced the same. If Sally consumes coffee and Ali consumes soft drinks, we can conclude that
Sally derives more utility from coffee than from tea or soft drinks, and Ali derives more utility from soft drinks than from tea or coffee
What is the saturated point?
TU= MAX & MU=0
What is utility analysis? What is the goal of this analysis?
Utility analysis is the analysis of consumer decision making based on utility maximization. Economists assume individuals act so as to maximize their utility. The goal of the analysis is to explain and predict consumer behavior. An important part of this is that utility analysis can be used to derive a demand curve, because utility governs people's preferences for goods and services
What is utility and what are its characteristics?
Utility is the want-satisfying power of a good or service. It is subjective, so that it cannot be measured objectively or by scientific instruments, and one person's utility cannot by compared to another's utility. It is not necessarily useful or utilitarian either. If an individual chooses a banana instead of an apple, we can say the person expects to receive more utility from the banana than from the apple
The real-income effect shows that
a decrease in the price of a good increases the purchasing power of the consumer's income
To remain in consumer optimum
a price decrease requires an increase in consumption
Util
a representative unit by which utility is measured
A representative unit that measures the want-satisfying power of a good is
a util
Despite the fact that water is necessary to sustain life, it is less expensive than soft drinks. Economic theory suggests that this is so because
although the total utility of water consumption is high, its marginal utility per dollar spent is low when compared to soft drinks
If marginal utility is zero, total utility is
at its maximum
If we are graphing total utility, then the total utility curve will
be increasing as long as marginal utility is positive
Observations of real-world situations that appear to violate a consumer optimum could be offered as evidence favoring
bounded rationality
The fact that the price of diamonds is higher than the price of water
can be explained as the outcome of a consumer optimum in consumer choice theory
The law of demand is derived under the assumption of
constant consumer tastes and preferences
If a consumer concludes that the marginal utility of the last dollar spent on vegetables exceeds the marginal utility of the last dollar spent on junk food, he will respond by
consuming relatively more vegetables and less junk food
The law of diminishing marginal utility implies that the marginal utility for a particular product
decrease as more of the product is consumed
The real-income and the substitution effects reinforce each other by
decreasing the consumption of good x when the price of good x increases
The inverse relationship between quantity demanded and price of a good or service can be explained, in part, by
diminishing marginal utility and the rule of equal marginal utilities per dollar
On a hot summer day, a construction worker enters a McDonald's fast-food restaurant. He orders the first Big Mac. He consumes it within 3 minutes. Then he orders a second Big Mac and consumes it in 10 minutes. He eats only half of the third one in 18 minutes and throws away the rest. The store manager offers him the fourth for free. The construction workers says "No thanks." For the construction worker described above, we can say that
diminishing marginal utility began as soon as he had eaten the first Big Mac
In economic utility analysis, consumer tastes and preferences are assumed
given and stable for an individual
The total utility of water is
higher than the total utility of diamonds, but marginal utility of diamonds is higher
Utility analysis helps economists understand
how people make decisions about what they buy and how much
The substitution effect shows that
if the price of a good rises, consumers buy less of that good and more of others
A rational individual will never consume a unit of a good if its
marginal utility is negative
The consumer optimum is the set of goods and services, subject to the limited income of the consumer, that
maximizes the level of satisfaction for each consumer
If a person claims, "I wouldn't eat liver if you paid me," we can assume that his marginal utility of liver is
negative
If someone complains that she doesn't feel very well because she ate too much pizza, we would conclude that the marginal utility of the last piece of pizza eaten was
negative
A consumer has spent all of his funds on hamburgers and movies. The price of hamburger is $1 and the price of a movie is $5. The marginal utility of the last hamburger is 5 and the marginal utility of the last movie is 40. This consumer has
not maximized utility. To maximize utility, he should cut back on movies and buy more hamburgers.
Because the behavioral economics approach suggests many alternative behaviors that people might exhibit if they fail to behave as if they are rational, this approach
often fails to provide clearly testable behavioral predictions
One piece of evidence that possibly supports the bounded-rationality assumption of behavioral economics is that experiments appear to have shown that
people make different decision in calm situations than in situations in which emotions come into play
Suppose that a consumer is at the optimum consuming X and Y. If the price of X falls, then to get to a new equilibrium the consumer must
purchase more X
If the price of a good is zero, a rational consumer will
stop consuming the good when total utility is maximized
Utility Analysis
the analysis of consumer decision making based on utility maximization
According to the substitution effect, if the price of a product goes down
the consumer will buy more of the good at the lower price than at the higher price, creating a downward sloping demand curve
Given the utility-optimizing rule and the presence of diminishing marginal utility for a good,
the demand curve for the good will be negatively sloped
The real-income effect of a price change is most significant when
the good under consideration constitutes a major portion of the consumer's budget
Olga buys a bag of potato chips every day after her economics class. The first potato chip always tastes wonderful. The second does not taste quite as good as the first. The third does not taste quite as good as the second. Olga is experiencing
the law of diminishing marginal utility
The principle that "as more of a good is consumed, its extra benefit declines" is known as
the law of diminishing marginal utility
In order to maximize utility, a consumer should allocate money income so that
the marginal utility obtained from the last dollar spent on each product is the same
The consumer optimum for consuming two goods is achieved when
the marginal utility per last dollar spent is equal for the two goods
The change in people's purchasing power that occurs when the price of a good they purchased changes, assuming all elsie is held constant is known as
the real income effect
The change in people's purchasing power that occurs when the price of a good they purchase changes, assuming all else is held constant is known as
the real-income effect
In economics, utility is defined as
the want-satisfying power of a good or service
Utility
the want-satisfying power of a good or service
Consumers do not buy as many units of each good as they want because
they have limited incomes
As marginal utility declines but remains positive, then
total utility continues to increase but at a decreasing rate
Economists use what term to describe the want-satisfying power of a good?
utility
The substitution effect argues that a consumer
will purchase more of a good that has become relatively cheaper, and less of a good that has become relatively more expensive.
