Today n Utility n n Diminishing Marginal Utility

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

Where does a household’s demand curve come from?

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

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

Diminishing Marginal Utility n n 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.

Example: Eating Pizza n 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 5 Slices/day

Your MU in $ Spent on Pizza n n 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 4 slices/day

Your Demand Curve for Pizza n 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 4 D slices/day

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

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

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

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

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

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

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

Smooth Graph of CS n $/unit n 8 A n 6 4 B D 2 1 2 3 4 5 6 7 units 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.

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

Now n Go over exams.