Utility Maximization Utility and Consumption Utility is a

Utility Maximization

Utility and Consumption Utility is a measure of personal satisfaction. A util is a unit of utility. A utility function shows the relationship between a consumer’s utility and the combination of goods and services—the consumption bundle—he or she consumes.

Utility and Consumption Panel (a) Panel (b) It increases Thatitis, each shows how shows the until reaches additional clam Cassie’s total marginal utility its maximum gives Cassie utility depends curve, which utility level of 64 less than on heratutility slopes utils 8 clams the previous consumption of downward due consumed and clam. fried clams. after to diminishing decreases marginal utility. that.

Principle of Diminishing Marginal Utility The marginal utility of a good or service is the change in total utility generated by consuming one additional unit of that good or service. According to the principle of diminishing marginal utility, successive units of a good or service add less total utility than do previous units.

Occasional Ups & Downs of Marginal Utility In rare cases, diminishing marginal utility doesn’t hold. For example, the first few times you go skiing, your utility may increase as you become more skilled and able to enjoy rather than fear the experience.

Occasional Ups & Downs of Marginal Utility For other goods, it is better to have none than to have not enough. For example, too little flooring would provide less utility than no flooring at all—because you would have to store a useless amount of the good. the principle of diminishing marginal utility applies in the majority of cases, so it will form the foundation of our analysis of consumer behavior.

Budget Constraints and Budget Lines A budget constraint limits the cost of a consumer’s consumption bundle to no more than the consumer’s income. A consumer’s consumption possibilities are the set of all affordable consumption bundles given the consumer’s income and prevailing prices. A consumer’s budget line (BL) shows the consumption bundles available to a consumer who spends all of his or her income.

Budget Constraints and Budget Lines The is alsoline the The. BL budget boundary between the (BL) shows all set of affordable possible consumption combinationsbundles of (the consumption quantities of possibilities) the tomatoes andand clams unaffordable Sammy can ones. buy if all income is spent.

The Optimal Consumption Bundle A consumer’s optimal consumption bundle is the consumption bundle that maximizes total utility given their budget constraint. Table 5. 1 shows that Sammy derives utility from both clams and tomatoes. Due to the budget constraint, however, Sammy must choose some combination of both goods.

The Optimal Consumption Bundle Table 51. 2 how Sammy’s total utility(A varies Each of sixshows possible consumption bundles Since total utility is highestbundles at 72. 0, C is his for the different through F from consumption the previous figure) isalong given in the Sammy’s optimal consumption bundle. budget line. first column.

The Optimal Consumption Bundle Panel (a): the budget line and six possible consumption bundles. Panel (b): how total utility is affected by each consumption bundle, which must lie on his budget line. This is Sammy’s optimal consumption bundle. Sammy’s total utility As more clams are is maximized due at bundle consumed, to his C, where he consumes fixed budget, Sammy 2 pounds of clams and must consume fewer 6 pounds of tomatoes.

Spending the Marginal Dollar The marginal utility per dollar spent on a good or service is the additional utility from spending one more dollar on that good or service.

Marginal Utility per Dollar Instep panel thethe first column shows Panel (b)isprovides same information for each The next to(a), derive marginal utility per different dollar possible amounts of clam consumption. good. tomatoes.

Marginal Utility per Dollar To determine whether a consumer should buy more of one good or another, compare the marginal utility per dollar received from each good, not just the marginal utility received from each good.

Optimal Consumption Sammy’s optimal consumption bundle is C, where his marginal utility per dollar spent on clams, (MUC)/(PC) equals his marginal utility per dollar spent on tomatoes, (MUT)/(PT).

The Optimal Consumption Rule The optimal consumption rule says that in order to maximize utility, a consumer must equate the marginal utility per dollar spent on each good and service in the consumption bundle.

Summary and Review 1) What measures consumer satisfaction? 2) With what units is utility measured? 3) What is the change in total utility caused by consuming one more unit of a good? Utility. U. til s Marginal utility.

Summary and Review 4) What curve represents the relationship between marginal utility and the quantity of a good or service consumed? Marginal utility curve. 5) What is the principle of diminishing marginal utility? The principle states that in most cases, each successive unit of a good or service consumed generates less utility than the previous unit.

Summary and Review 6) What limits the cost of a consumer’s consumption bundle to no more than the consumer’s income? The budget constraint. 7) What is consumption bundle that maximizes total utility called? The optimal consumption bundle.

Summary and Review 8) What is marginal utility per dollar? The marginal utility of a good divided by its price. 9) What is the optimal consumption rule? The rule states that the optimal consumption bundle occurs at the quantities of each good where their marginal utility per dollar is the same.

Walkthrough: Free-Response Question 1 1. Refer to the table provided. Assume you have $20 to spend. a. Draw a correctly labeled budget line. b. Determine the marginal utility and the marginal utility per dollar spent on the fourth drink. c. What is the optimal consumption rule? d. How many drinks and snacks should you purchase to maximize your total utility? (6 points) 1 point: Graph with “Quantity of snacks” and “Quantity of drinks” as axis labels 1 point: Straight budget line with intercepts at 5 snacks and 0 drinks and 0 snacks and 10 drinks 1 point: MU = 7 utils 1 point MU / P = 3. 5 utils per dollar 1 point: Total utility is maximized when the marginal utility per dollar is equal for all goods. 1 point: 6 drinks, 2 snacks