1–1

Chapter 2 Chapter 2 Consumer Choice Consumer Choice TheoryTheory

1–2

Learning ObjectivesLearning Objectives

1.1.• • Utility, Total Utility and Marginal Utility.Utility, Total Utility and Marginal Utility.2.2.• • Maximizing Total UtilityMaximizing Total Utility3.3.• • Maximizing Total Utility – consumer Maximizing Total Utility – consumer equilibriumequilibrium

1–3

1. Utility, Total Utility and Marginal Utility1. Utility, Total Utility and Marginal Utility

● UtilityUtility - The - The satisfactionsatisfaction, or pleasure, , or pleasure, that people that people receivereceive from consuming a from consuming a good or service.good or service.

● UtilUtil - A - A hypothetical unit hypothetical unit used to used to measure how much utility a person measure how much utility a person obtains from consuming a good.obtains from consuming a good.

1–4

Utility (satisfaction) is typically measured Utility (satisfaction) is typically measured in dollars according to the willingness to in dollars according to the willingness to pay principle.pay principle.

What is the most that you are willing to What is the most that you are willing to pay for that product?pay for that product?

1–5

● Total utility Total utility – The – The total satisfaction total satisfaction a a person person receivesreceives from consuming a from consuming a particular quantity of a good.particular quantity of a good.

● Marginal utility Marginal utility – The – The additional additional utilityutility a person receives a person receives from from consuming an additional unit consuming an additional unit of a of a particular product. (MU= ∆TU/ ∆Q)particular product. (MU= ∆TU/ ∆Q)

1–6

Example 1Example 1

Units of apple Total utility (TU)

1 50 utils

2 80 utils

What is the marginal utility of the second apple?

Or what is the additional utility of consuming an additional apple?

1–7

The Law of Diminishing Marginal UtilityThe Law of Diminishing Marginal Utility

The principle that the The principle that the extra extra satisfactionsatisfaction of a good or service of a good or service declinesdeclines as people consume as people consume more more in a given period.in a given period.

The The more of a specific product more of a specific product consumerconsumer obtains, the obtains, the less less they they will will desire more unitsdesire more units of that of that product.product.

1–8

IllustrationIllustration

Units of hamburger Total Utility (TU) Marginal Utility (MU)

0 0

1 20

2 35

3 47

4 56

5 61

6 61

7 59

1–9

-5

0

5

10

15

20

25

1 2 3 4 5 6 7

Quantity of hamburger

Marg

inal

Uti

lity

(u

tils

)

0

10

20

30

40

50

60

70

1 2 3 4 5 6 7

Quantity of hamburger

To

tal

uti

lity

(u

tils

)

1–10

2. Maximizing Total Utility2. Maximizing Total Utility

When the When the marginal utility per dollar marginal utility per dollar of each good is equalof each good is equal

and the and the entire budget is entire budget is spentspent

1–11

Example 2: (Big Macs and Milkshakes = $2 each)

Quantity MU MU/P MU MU/P

1

2

3

4

8

4

2

1

4

2

1

1/2

6

4

1

0

3

2

1/2

0

BIG MACS MILKSHAKES

1–12

Example 2Example 2

marginal utility per dollar of marginal utility per dollar of each good is equaleach good is equal

Possible Combinations:Possible Combinations: i.i. ii.ii.entire budget is spent ($8)entire budget is spent ($8)

1–13

3. Maximizing Total Utility – consumer 3. Maximizing Total Utility – consumer equilibriumequilibrium

Consumer equilibrium = a condition in which total utility cannot increase by spending more of a given budget on one good and spending less on another good.

1–14

MU Aprice A

MU Bprice B

Consumer Equilibrium

MU Zprice Z= =

1–15

MU of Big Macprice of Big

Mac

MU of milkshakeprice of

milkshake

Example 3: (Price of Big Mac = $2)

4 utils$2

4 utils$2 =

=

1–16

Example 3aExample 3a

What happens if the price of a Big Mac What happens if the price of a Big Mac fallsfalls to to $1 $1 and upsets the previous equilibrium?and upsets the previous equilibrium?

4 ≠ 2 4 ≠ 2

Consumer does not achieve consumer Consumer does not achieve consumer equilibrium. equilibrium.

MU of Big Macprice of Big Mac >

MU of milkshakeprice of milkshake

4 utils$1

4 utils$2

>

1–17

What should the consumer do in What should the consumer do in order to restore maximum total order to restore maximum total utility? utility?

To restore maximum total utility, the To restore maximum total utility, the consumer consumer spends more on Big spends more on Big Macs, spends less on milkshake.Macs, spends less on milkshake.

Example 3bExample 3b

1–18

Exercise 4Exercise 4

Quantity Product A: Price RM2 Product B: Price RM4

MU MU/RM MU MU/RM

1 10 24

2 8 20

3 7 18

4 6 16

5 5 12

6 4 6

7 3 4

What are the possible combinations of Product A and B?

1–19

SummarySummary

1. Utility is the satisfaction or pleasure derived from consumption of a good or service. Actual measurement is impossible, but economists assume it can be measures by a fictitious unit called the util.

2. Total utility is the total level of satisfaction derived from all units of a good or service consumed.

3. Marginal utility is the change in total utility from a 1-unit change in the quantity of a good or service consumed.

1–20

SummarySummary

4. The law of diminishing marginal utility states that the marginal utility of a good or service eventually declines as consumption increases.

5. Relationship between Marginal and Total Utility When TU increases, MU decreases but remain as positiveWhen TU at maximum, MU equals zeroWhen TU decreases, MU continue decreases but become negative

1–21

SummarySummary

6. Consumer equilibrium is the condition of reaching the maximum level of satisfaction, given a budget, when the marginal utility per dollar spent on each good purchased is equal.