Chapter 5: Applications of the Derivative Chapter 4: Derivatives Chapter 5: Applications.
Chapter 5
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Consumer Choice & Utility Maximization By Laura Lamb, TRU with some insertions from Bruno Fullone, George Brown College 1
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Chapter 5 . Consumer Choice & Utility Maximization By Laura Lamb, TRU with some insertions from B runo Fullone, George Brown College. 5.1 Law of Diminishing Marginal Utility. Although consumer wants in general are insatiable, wants for specific commodities can be fulfilled. - PowerPoint PPT Presentation
Transcript of Chapter 5
Consumer Choice & Utility Maximization
By Laura Lamb, TRU with some insertions from Bruno Fullone, George
Brown College
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Although consumer wants in general are insatiable, wants for specific commodities can be fulfilled.
The more of a specific product that consumers obtain, the less they will desire more units of that product.
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Gains in satisfaction decline as additional units are consumed
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Utility utility represents the amount of satisfaction a
person gets from consumption of a certain item.
Total Utility and Marginal Utility total utility: total amount of satisfaction marginal utility: extra satisfaction from
consuming one more unit
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Number of Cokes Sam drinks /day
Sam’s total utility
Sam’s marginal utility
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Total utility increases as Sam consumes each additional Coke up until ________________.
Although, utility rises at a ______________rate.
Marginal utility diminishes and then becomes _____________ as the _____Coke is consumed.
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A Typical Consumer… Exhibits rational behaviour Knows clear-cut preferences Is subject to a budget
constraint Responds to price changes
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The consumer’s money income should be allocated so that the last dollar spent on each product purchased yields the same amount of extra (marginal) utility
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MU of product APrice of A
MU of product B
Price of B=
Consumer behaviour is in equilibrium when utility is “balanced (per dollar) at the margin.”
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Daisy’s utility-maximizing combination of products obtainable with $22 income
Tacos ($2 each) Movies ($8 each)Quantity Total utility Quantity Total utility
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0112027303131
0123456
0326084104120132
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Daisy’s utility-maximizing combination of products obtainable with $22 income
Tacos ($2 each) Movies ($8 each)Quantity MU MU/$ Quantity MU MU/$
0123456
0123456
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MU(movies) = MU(tacos) Price per movie price per taco
What is Daisy’s utility maximizing combination of goods attainable?
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The concept of utility and consumer equilibrium can be illustrated with indifference curves and a budget line.
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Before marginal analysis, economists were puzzled by the fact that some essential goods like water had lower prices than luxuries like diamonds.
The paradox is resolved when we look at the abundance of water relative to diamonds.
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The total price of an item must include the value of the time spent in consuming the product.
When time is considered, consumer behaviour appears to be much more rational.
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Non-cash gifts may yield less utility to the receiver than a cash gift of equal monetary value because the non-cash gift may not match the receiver’s preferences.
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In this chapter, we made the assumption that consumers make rational decisions.
Behavioural economics is a rising area of study & research in economics and some experimental research in this area shows that people are not always so rational.
◦ Dan Ariely: We’re All Predictably Irrational
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