Microeconomics Ch.7: Utility Maximization (Law of diminishing Marginal Utility & Theory of Consumer Behavior)

Income Effect

The impact a price change has on a consumer's real income. When price rise, consumer's real income falls because their purchasing power decrease. So consumer can demand less quantity. When price falls, consumer's real income rises because their purchasing power increased. So consumer can demand more quantity.

How to calculate Marginal Utility per dollar when solving for Maximum Marginal Utility.

Marginal Utility for product / Price of product

Utility Maximizing Rule

(Consumer Equilibrium) This means if the Consumer has 1 more dollar to spend, he/she will be indifferent to whether to spend it on Good 1 or Good 2 because they both give the same amount of utility or satisfaction to the consumer. MU of product A/Price of A = MU of product B/Price of B

Marginal Utility

. Marginal utility refers to the extra utility a consumer gets from one additional unit of a specific product. Change in Total Utility/Change in Quantity

Util

Unit of Satisfaction or Pleasure

Law of Diminishing Marginal Utility

As consumption increase, the marginal utility from that additional consumption decrease Explains Downward Sloping Demand Curve

Utility Maximizing and Consumer Equilibrium Intuition

How does Jim maximize his utility when faced with choosing multiple products and having to worry about prices? Let's say Jim is at the food court. He has two options, Pizza or Soda. Marginal Utility of 1 pizza is 100 utils. Marginal Utility of 1 Soda is 50 utils. To maximize utility, which should Jim pick first? If Jim has no worries about income or price, he will choose the pizza. However, in reality prices DO matter. So in this case, let's say 1 Pizza = $2.50 1 Soda = $1.00 If Jim considers how to get the most added satisfaction per dollar spent with each spending decision, then he will achieve the maximum possible utility when all his income is spent. So which product, Pizza or Soda, yields greater marginal utility Per Dollar? Well, Marginal Utility per dollar for Pizza is MUpizza/Ppizza = 100/$2.50 = 40 utils/dollar. Marginal Utility per dollar for Soda is MUsoda/Psoda = 50/$1.00 = 50 utils/dollar. So Jim should first buy the Soda because it holds greater marginal utility per dollar than the pizza when price and income is factored in. But once Jim buys the Soda, because of the law of diminishing marginal utility, Marginal Utility for Soda will fall. Eventually, as Jim continues to buy the product with the greater marginal utility per dollar spent every time, an equilibrium will be reached where Marginal Utility per dollar of Pizza equals Marginal Utility per dollar of Soda. This means, if Jim is given another dollar, he will be indifferent to which product to choose because they both give equal marginal utility per dollar. That is when Jim Maximized his Utility.

Theory of Consumer Behavior

Rational Behavior Preferences Budget Constraint Prices

Substitution Effect

The impact a price change on a product's relative expensiveness. If price of a product falls, this decreases its relative expensiveness, so consumers will substitute more of this good for the other. Also when price of product falls, the consumer will no longer be in equilibrium until more of the item is purchased and the marginal utility of the item declines to match the decline in price. If price of a product rise, Vice Versa then.

Total Utility

Total utility is the total amount of satisfaction one gets from the consumption of a single product or a combination of products. Total utility can be derived by adding up the utils of successive units consumed.