Transcript Slide 1

the pleasure people get from
doing or consuming something
Which is more valuable water or diamonds?
“Why are you going out? Are your
friends more important to you than
me?”
Some things have High Total
Utility, but Smaller Marginal Utility
Diminishing Marginal Utility
• After some point, the marginal utility received from
each additional unit of a good decreases with each
additional unit consumed
• As additional units are consumed,
marginal utility decreases, but total
utility continues to increase
• When total utility is at a maximum,
marginal utility is zero
• Beyond this point, total utility decreases
and marginal utility is negative
Total Utility Curve
The total utility
curve is bowed
downward
Utility
70
Marginal Utility Curve
14
60
12
50
10
40
8
30
6
20
4
10
2
1
2
3
4
5
6
7
8
The marginal utility
curve is downward
sloping and graphed
at the halfway point
Utility
Q 0
–2
1
2
3
4
5
6
7
8
Q
MUB
MUN
MUA
=
=
.
.
.
=
PB
PN
PA
Choices are based on comparisons
of MU per $ spent on each good
until choices are equal.
Marginal Utility per $
Number
Bought
Domestic
$1
MU
Imported
$2
MU
1
10
24
Domestic
MU/$
____
2
8
20
____
____
3
7
18
____
____
4
6
16
____
____
5
5
12
____
____
6
4
6
____
____
7
3
4
____
____
With Constraint
Imported
MU/$
____
Without Income Constraint? With $12?
Why the Demand Curve slopes down
One Reason:
Substitution Effect
At a lower price consumers can
switch to the cheaper good,
substituting the cheaper for
the more expensive.
Why the Demand Curves slopes down
A Second Reason:
Income Effect
A lower price of a good will
increase purchasing power
of the consumer. They can
buy more than before.
Why the Demand Curves slopes down
A Third Reason:
Diminishing Utility
Consumers get less satisfaction
as they buy more of a good.
For the consumer to buy more
the price must be reduced.
The Pizza Demand Curve
• The demand for frozen pizzas
reflects the law of diminishing
marginal utility.
• Because marginal utility (MU)
falls with increased consumption,
so does a consumer’s maximum
willingness to pay -- marginal
benefit (MB).
John’s demand curve
for frozen pizza
MB1
$3.50
MB2
$3.00
MB3
Price =$2.50
$2.50
• A consumer will purchase until
MB = Price . . . so at $2.50
they would purchase 3 frozen
pizzas and receive a consumer
surplus shown by the shaded
area (above the price line and
below the demand curve).
MB4 < MB3 < MB2 < MB1
because
MU4 < MU3 < MU2 < MU1
MB4
$2.00
d = MB
1
2
3
4
Frozen pizzas
per week
Wage Rates and Labor Supply
Wage
S
$10.00
The higher the wage,
the higher the marginal
utility of the goods you
can get for the wage
$8.50
This gives an upward
sloping supply curve
$8.00
20 21
26
Hours
per week
Applying the Theory of Choice
to the Real World
• The assumptions underlying the theory of
rational decision making place limits on the
use of the theory
• Those assumptions are:
1. Decision making is costless
2. Tastes are given
3. Individuals maximize utility
• Behavioral economists question all three assumptions
Decision making is costless
• The costs of deciding among hundreds of possible choices
may lead us to do some things that seem irrational
• Most people may use bounded
rationality which is rationality based on
rules of thumb
•
“You get what you pay for” is the implication that high price
equals high quality
•
“Follow the leader” leads to focal point equilibria in which
a set of goods is consumed because they have become
focal points to which people have gravitated
Tastes are given
• Implicit in the theory of rational choice is that
utility functions are given, not shaped by society
• Tastes are often significantly
influenced by society
• Conspicuous consumption is the consumption of goods
not for one’s direct pleasure, but to show off to
others
• “Given tastes” is the assumption on which an
economic analysis is conducted
Item
Pants
Price
$60
Utility
125
Shirt
$40
100
Wallet
$20
50
If Mr. Smith thinks the last dollar spent on shirts
satisfaction than the last dollar spent on cola, and
maximizing consumer, he should
a.decrease his spending on cola.
b.decrease his spending on cola and increase his
c. increase his spending on shirts.
d.increase his spending on cola and decrease his
yields less
Smith is a utilityspending on shirts.
spending on shirts.
“I like ice cream, but after eating homemade ice cream last night, I want to
have something else for dessert today.” This statement most clearly reflects
a. the budget constraint.
b. consumer irrationality.
c. the second law of demand: Price elasticity increases with time.
d. the law of diminishing marginal utility.
If the price of gasoline goes up, and Dan now buys fewer candy bars because
he has to spend more on gas, this would best be explained by
a. the substitution effect.
b. the income effect.
c. the highly elastic demand for gasoline.
d. weight watchers effect.