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MICROECONOMICS

Utility and demand

Maximizing Utility
Preferences
A households preferences determine the benefits or satisfaction a

person receives consuming a good or service.


The benefit or satisfaction from consuming a good or service is
called utility.

Total Utility
Total utility is the total benefit a person gets from the
consumption of goods. Generally, more consumption gives more
utility.

Maximizing Utility
Table 1 provides an example

of total utility schedule.


Total utility from a good
increases as the quantity of
the good increases.
For example, as the number
of movies seen in a month
increases, total utility from
movies increases.

Maximizing Utility
Marginal Utility
Marginal utility is the change in total utility that results from a
one-unit increase in the quantity of a good consumed.
As the quantity consumed of a good increases, the marginal utility
from consuming it decreases.
We call this decrease in marginal utility as the quantity of the good
consumed increases the principle of diminishing marginal utility.

Maximizing Utility
Table 8.1 provides an

example of marginal utility


schedule.
Marginal utility from a good
decreases as the quantity of
the good increases.
For example, as the number
of movies seen in a month
increases, marginal utility
from movies decreases.

Maximizing Utility
Figure 8.1(a) shows a total

utility curve for soda.


Total utility increases with
the consumption of a soda
increases.

Maximizing Utility
Figure 8.1(b) illustrates

diminishing marginal utility.


As the quantity of soda
increases, the marginal utility
from soda diminishes.

Maximizing Utility
The key assumption of marginal utility theory is that the household

chooses the consumption possibility that maximizes total utility.

The Utility-Maximizing Choice


We can find the utility-maximizing choice by looking at the total
utility that arises from each affordable combination.
The utility-maximizing combination is called a consumer
equilibrium.

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Maximizing Utility
Table 8.2 shows Lisas utility-

maximizing choice.
Lisa has $40 a month to spend
on movies and soda.
The price of a movie is $8 and
the price of soda is $4 a case.
Each row of the table shows a
combination of movies and soda
that exhausts Lisas $40.

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Maximizing Utility
Lisa chooses the combination

that gives her the highest total


utility.
Lisa maximizes her total utility
when she sees
2 movies and drinks 6 cases of
soda a month.
Lisa gets 90 units of utility from
the 2 movies and 225 units of
utility from the 6 cases of soda.

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Maximizing Utility
Choosing at the Margin
A consumers total utility is maximized by following the rule:
Spend all available income.
Equalize the marginal utility per dollar for all goods.
The marginal utility per dollar is the marginal utility from a good
divided by its price.

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Maximizing Utility
The Utility-Maximizing Rule:
Call the marginal utility of movies MUM .

Call the marginal utility of soda MUS .

Call the price of movies PM .

Call the price of soda PS .

The marginal utility per dollar from seeing movies is MUM/PM .

The marginal utility per dollar from soda is MUS/PS.

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Maximizing Utility
Total utility is maximized when:
MUM/PM = MUS/PS
Table 8.3 shows why the

utility-maximizing rule works.


The combination is each row
is affordable (costs $40).
In row C,
MUM/PM = MUS/PS = 5.

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Maximizing Utility
If MUM/PM > MUS/PS,
then spend less on soda

and more on movies.


MUM decreases and
MUS increases.
Only when

MUM/PM = MUS/PS,
is it not possible to reallocate
the budget and increase total
utility.

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Maximizing Utility
If MUS/PS > MUM/PM,
then spend more on soda and

less on movies.
MUS decreases and
MUM increases.
Only when

MUM/PM = MUS/PS,
is it not possible to reallocate
the budget and increase total
utility.