Distinguish between total utility and marginal utility Discuss why marginal utility at first rises but ultimately tends to decline as a person consumes more of a good or service
Slide 19-3
Explain why an individual’s optimal choice of how much to consume of each good or service entails equalizing the marginal utility per dollar spent across all goods and services Describe the substitution effect of a price change on the quantity demanded of a good or service Slide 19-4
1
Learning Objectives
Chapter Outline
Understand how the real-income effect of a price change affects the quantity of a good or service demanded Evaluate why the price of diamonds is so much higher than the price of water even though people cannot survive long without water
Utility Theory Graphic Analysis Diminishing Marginal Utility Optimizing Consumption Choices How a Price Change Affects Consumer Optimum The Demand Curve Revisited
Slide 19-5
Slide 19-6
Did You Know That...
Utility Theory
Online shoppers do not spend much time comparing prices of the same items at other Web sites? A reduction in overall time spent locating and selecting an item reduces its cost?
Utility – The want-satisfying power of a good or service
Utility Analysis – The analysis of consumer decision making based on utility maximization
Util – A representative unit by which utility is measured
Slide 19-7
Slide 19-8
2
Total and Marginal Utility of Watching Videos
Utility Theory Marginal Utility – The change in total utility due to a one-unit change in the quantity of a good or service consumed
Marginal utility =
change in total utility change in number of units consumed
Slide 19-9
Figure 19-1, Panel (a)
Slide 19-10
Total and Marginal Utility of Watching Videos
Graphic Analysis A graph can be used to display the values displayed in the table to better see their relationships.
Slide 19-11
Figure 19-1, Panel (b)
Slide 19-12
3
Total and Marginal Utility of Watching Videos
Total and Marginal Utility of Watching Videos Total utility is maximized...
20
10
16 Marginal Utility (utils per week)
Total Utility (utils per week)
18
14 12 10 8 6 4 2 0
Slide 19-13
Total and Marginal Utility of Watching Videos
6 4 2 0 -2
1
-4 1
2
3
4
5
6
DVDs Watched per Week
Figure 19-1, Panel (c)
8
Figure 19-1, Panels (b) and (c)
2
3
4
5
6
7
DVDs Watched per Week
7 …where marginal utility equals zero.
Slide 19-14
Diminishing Marginal Utility
Observations
Diminishing Marginal Utility
– Marginal utility falls – Marginal utility = 0 when total utility is at its maximum
– The principle that as more of any good or service is consumed, its extra benefit declines – Increases in total utility from consumption of a good or service become smaller and smaller as more is consumed during a given time period
Slide 19-15
Slide 19-16
4
Newspaper Vending Machines versus Candy Vending Machines How many people take more than one paper from the vending machine? Why not dispense candy the same way?
Optimizing Consumption Choices Consumer Optimum – A choice of a set of goods and services that maximizes the level of satisfaction for each consumer, subject to limited income
Slide 19-17
Slide 19-18
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26
DVDs per Period
Total Utility of DVDs per Period (utils)
Marginal Utility (utils) MUd
Marginal Utility per Dollar Spent (MUd/Pd) (Price = $5)
Pizza Slices per Period
Total Utility of Pizza Slices per Period (utils)
Marginal Utility (utils) MUp
Marginal Utility per Dollar Spent (MUpPp) (price = $3)
0
0.0
——
——
0
0.0
——
——
1
50.0
50.0
10.0
1
25
25
8.3
2
95.0
45.0
9.0
2
47
22
7.3
3
135.0
40.0
8.0
3
65
18
6.0
4
171.5
36.5
7.3
4
80
15
5.0
5
200.0
28.5
5.7
5
89
9
3.0
Slide 19-19
Slide 19-20
5
Total and Marginal Utility from Consuming DVDs and Pizza Slices on an Income of $26 Items per Period
Marginal Utility per Dollar Spent (DVD) (price = $5)
Marginal Utility per Dollar Spent (Pizza) (price = $3)
0
——
——
1
10.0
8.3
2
9.0 8.0
6.0
4
7.3
5.0
5
5.7
Choices DVDs
7.3
3
Steps to Consumer Optimum
3.0
Pizza Slices
Purchase
Unit
(MUd/Pd)
Unit
1
First
10.0
First
8.3
2
Second
9.0
First
8.3
3
Third
8.0
First
8.3
4
Third
8.0
Second
7.3
5
Fourth
7.3
Second
7.3
Slide 19-21
Steps to Consumer Optimum Buying Decision First DVD
Remaining Income
$21 - $5 = $16
First pizza slice
$16 - $3 = $13
Third DVD
$13 - $5 = $ 8
Fourth DVD and second pizza slice
Slide 19-22
Optimizing Consumption Choices A little math – The rule of equal marginal utilities per dollar spent
$26 - $5 = $21
Second DVD
(Mup/Pp)
• A consumer maximizes personal satisfaction when allocating money income in such a way that the last dollars spent on good A, good B, good C, and so on yield equal amounts of marginal utility
$8 - $5 = $ 3 $3 - $3 = $ 0
Slide 19-23
Slide 19-24
6
Optimizing Consumption Choices
How a Price Change Affects Consumer Optimum
A little math
Income = $26
– The rule of equal marginal utilities per dollar spent MU of good B MU of good A MU of good Z = = ... = price of good B price of good A price of good Z
Qd = 4
MUd 36.5 = 7.3 = Pd 5
Qp = 2
MUp 22 = Pp 3
= 7.3
Slide 19-25
Slide 19-26
How a Price Change Affects Consumer Optimum
How a Price Change Affects Consumer Optimum
Assume Price of DVDs Falls to $4
Assume Price of DVDs Falls to $4
Qd = 4
MUd 36.5 = 9.13 = Pd 4
Qp = 2
MUp 22 = Pp 3
= 7.3
Slide 19-27
Now Result
MUd MUp > Pd Pp Buy more DVDs and MUd falls
Slide 19-28
7
DVD Rental Prices and Marginal Utility
How a Price Change Affects Consumer Optimum
Price per Unit ($ per DVD)
The Substitution Effect – The tendency of people to substitute cheaper commodities for more expensive commodities
A
5
B
4
D 0 Figure 19-2
1
3 2 DVD Rentals per Week
Slide 19-29
How a Price Change Affects Consumer Optimum The Principle of Substitution
Slide 19-30
How a Price Change Affects Consumer Optimum Purchasing Power
– Consumers and producers shift away from goods and resources that become relatively higher priced in favor of goods and resources that are now lower priced
Slide 19-31
– The value of money for buying goods and services
Slide 19-32
8
How a Price Change Affects Consumer Optimum Real-Income Effect
How a Price Change Affects Consumer Optimum What do you think?
– The change in people’s purchasing power that occurs when, other things being constant, the price of one good that they purchase changes
– Which would usually have more of an impact, the substitution or the realincome effect?
Slide 19-33
Slide 19-34
The Demand Curve Revisited
The Demand Curve Revisited
Question
Marginal utility, total utility, and the diamond-water paradox
– How is the demand curve derived?
– Water is essential to life but cheap
Answer – By assuming income, tastes, expectations, and the price of related goods are not changing as the price and quantity demanded of the good changes Slide 19-35
– Diamonds are not essential to life but expensive
Slide 19-36
9
The Diamond-Water Paradox Price (dollars per kilogram)
Price (dollars per kilogram)
The Diamond-Water Paradox
Pdiamonds
Pwater Ddiamonds
S2
Pdiamonds
Pwater
Dwater
Ddiamonds Qdiamonds
Figure 19-3
Quantity per Period (kilograms)
S1
Slide 19-37
Figure 19-3
Dwater
Qwater Quantity per Period (kilograms)
Slide 19-38
International Example: The World of Water in Saudi Arabia
Issues and Applications: Consumer Choice and Electronic Tax Filings
Water is five times more expensive than gasoline in Saudi Arabia.
Tax preparation software packages vary in price, depending on the features offered.
Question
A taxpayer will be willing to pay a higher price for a package that offers her a higher marginal utility.
– How can we explain this reversal of the U.S. prices?
Electronic filings are less error-prone. Slide 19-39
Slide 19-40
10
Summary Discussion of Learning Objectives
Web Links The following Web link appears in the margin of this chapter in the textbook: – http://www.finfacts.ie/Private/win_rst/ w_mar24.htm
Total utility versus marginal utility – Total utility is total satisfaction from consumption – Marginal utility is the additional satisfaction from consuming an additional unit of a good
Law of diminishing marginal utility – Marginal utility eventually declines with additional consumption
Slide 19-41
Summary Discussion of Learning Objectives
Slide 19-42
Summary Discussion of Learning Objectives
The substitution effect of a price change
The real-income effect of a price change
– A person will substitute among goods by buying less of a good when its price increases
The consumer optimum – Occurs when the marginal utility per dollar spent on each good is the same Slide 19-43
– A price change affects the purchasing power of a person’s income
Why the price of diamonds exceeds the price of water even though people cannot long survive without water – marginal utility determines how much people are willing to buy