Utility 2 5 Utility Theory Utility is a

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Utility

Utility

2. 5 Utility Theory • Utility is a measure of satisfaction. • Given this

2. 5 Utility Theory • Utility is a measure of satisfaction. • Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain economic behavior in terms of attempts to increase one's utility.

Utility Theory • Total utility (TU) is the total utility a consumer gets from

Utility Theory • Total utility (TU) is the total utility a consumer gets from the consumption of all of the units of a good. • Marginal utility (MU) is the utility a consumer gets from the last unit of a consumer good that she or he consumes. • Total utility = Sum of marginal utilities

Total Utility (TU) vs Marginal Utility (MU) Coffee/Pizza TU (Util) MU (Util) 0 0

Total Utility (TU) vs Marginal Utility (MU) Coffee/Pizza TU (Util) MU (Util) 0 0 - 1 5 5 2 ? 4 3 12 3 4 14 2 5 15 1 6 15 0 7 ? -1 TU of 2 cups of coffee = 5+4 = 9 Util TU of 7 cups of coffee = 5 + 4 + 3 + 2 + 1 + 0 + (-1) = 14 Util

Total Utility (TU) vs Marginal Utility (MU) Coffee/Pizza TU (Util) MU (Util) 0 0

Total Utility (TU) vs Marginal Utility (MU) Coffee/Pizza TU (Util) MU (Util) 0 0 - 1 5 5 2 9 ? 3 12 3 4 14 2 5 15 1 6 15 0 7 14 ? MU of 2 nd cup of coffee = (9 – 5) / 1 = 4 Util MU of 7 th cup of coffee = (14 – 15) / 1 = -1 Util

Total Utility (TU) vs Marginal Utility (MU) TUn = MU 1 + MU 2

Total Utility (TU) vs Marginal Utility (MU) TUn = MU 1 + MU 2 +. . . + MUn n TUn = MUi or i=1 MUn = TUn - TUn – 1 MUn = TU Q

Total Utility (TU) vs Marginal Utility (MU) • When MU is positive >> TU

Total Utility (TU) vs Marginal Utility (MU) • When MU is positive >> TU increases • When MU is negative >> TU decreases • When MU = 0 >> TU is at its maximum value!

The law of diminishing marginal utility Principle that as more of a good is

The law of diminishing marginal utility Principle that as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility.

The Consumer’s Optimal Choice • Consumers choose the amount of goods that gives the

The Consumer’s Optimal Choice • Consumers choose the amount of goods that gives the highest total utility. • Notice that if the 1 util is translated into $1, then the MU curve is simply the demand curve.

The Consumer’s Optimal Choice • Note: In the case, in which the consumers have

The Consumer’s Optimal Choice • Note: In the case, in which the consumers have budget constraint, the consumers choose the amount that give the highest total utility given the constraint.