Consumer Choice and Utility Maximization

1

The Law of Diminishing “ADDITIONAL” “SATISFACTION”

2

Would you see the movie three times?Notice that the total benefit is more than the

total cost but you would NOT watch the movie the 3rd time.

Thinking at the Margin

# Times Watching Movie

Marginal Utility

Price

1st $30 $102nd $15 $10

3rd $5 $10Total $50 $30

Calculate Marginal Utility# of Slices of

PizzaTotal Utility

(in utils)Marginal

Utility/Benefit

0 0

1 8

2 14

3 19

4 23

5 25

6 26

7 26

8 24

How many pizzas would you buy if the price per slice was $2? 4

Calculate Marginal Utility# of Slices of

PizzaTotal Utility (in dollars)

Marginal Utility/Benefi

t

0 0 0

1 8 8

2 14 6

3 19 5

4 23 4

5 25 2

6 26 1

7 26 0

8 24 -2

How many pizzas would you buy if the price per slice was $2?

Marginal Cost

$2

$2

$2

$2

$2

$2

$2

$2

$2

5

Calculate Marginal Utility# of Slices of

PizzaTotal Utility (in dollars)

Marginal Utility/Benefi

t

0 0 0

1 8 8

2 14 6

3 19 5

4 23 4

5 25 2

6 26 1

7 26 0

8 24 -2

How many pizzas would you buy if the price per slice was $2?

Marginal Cost

2

2

2

2

2

2

2

2

2

You will continue to consume until

Marginal Benefit = Marginal Cost

6

CONSUMER BEHAVIOR

You plan to take a vacation and want to maximize your utility. Based on the info below, which should

you choose?

Destination Marginal Utility(In Utils)

Price

Tahiti 3000 $3,000

Chicago 1000 $500

Marginal Utility Per Dollar

1 Util

2 Utils

7

CONSUMER BEHAVIOR

You plan to take a vacation and want to maximize your utility. Based on the info below, which should

you choose?

Destination Marginal Utility(In Utils)

Price

Tahiti 3000 $3,000

Chicago 1000 $500

Marginal Utility Per Dollar

1 Util

2 Utils

Calculating Marginal Utility Per Dollar allows you to compare products with different prices.

8

If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization

# Times Going

Marginal Utility

(Movies)

MU/P(Price =$10)

Marginal Utility

(Go Carts)

MU/P(Price =$5)

1st 30 102nd 20 53rd 10 24th 5 1

$10 $5

If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization

# Times Going

Marginal Utility

(Movies)

MU/P(Price =$10)

Marginal Utility

(Go Carts)

MU/P(Price =$5)

1st 30 3 10 $22nd 20 $2 5 $13rd 10 $1 2 $.404th 5 $.50 1 $.20

$10 $5

If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization

# Times Going

Marginal Utility

(Movies)

MU/P(Price =$10)

Marginal Utility

(Go Carts)

MU/P(Price =$5)

1st 30 3 10 22nd 20 $2 5 $13rd 10 $1 2 $.404th 5 $.50 1 $.20

$10 $5

If you only have $25, what combination of movies and go carts maximizes your utility?

Utility Maximization

# Times Going

Marginal Utility

(Movies)

MU/P(Price =$10)

Marginal Utility

(Go Carts)

MU/P(Price =$5)

1st 30 3 10 22nd 20 2 5 13rd 10 1 2 .404th 5 .50 1 .20

$10 $5

Production= Converting inputs into output

WidgetProduction Simulation

AnalyzingProduction Lets look at an example

to show the relationship between inputs and

outputs

Production SimulationOverview• The class will be divided into two firms. • There will be several rounds in which each firm will produce chains out

of paper. • Each round last exactly 2 minutes • Each firm is going to hire one more worker at the start of each round. Resources• 1 stapler, 1 scissors, 1 table, and plenty of staples and paper Rules• Workers cannot stockpile slips of paper. No extras • Workers cannot cut more than one paper at a time • Workers can only add links to one side of the chain• Each link must pass inspection• If links don’t meet specifications they won’t countResponsibilities• The manager will hire the workers.• The inspector will check to make sure each product is made to

specifications

Production Simulation

Step 1: Cut paper down the middle

into two piece

Step 2: Fold piece down the middle

Step 3: Wrap ends around and staple

Step 4: Add more links to one end

Complete the chart for your firm:

Production Simulation

Number of Workers (inputs)

Total Product (output)

Marginal Product

0

1

2

3

4

5

6

Simulation DebriefKey Questions: 1. What happened to the number on links

produced as more workers were hired?2. Why can the second worker generate more

additional links than one worker working alone?

3. Why did the additional output for each worker eventually start to fall or even go negative?

4. What would happen to total output if every student in the room tried to make links given the limited resources?

Simulation Debrief

Fixed Resources-Resources that DON’T change with the amount producedEx: Stapler, scissors, and table

Variable Resources-Resources that DO change as more or less is producedEx: Workers, paper, and staples

Simulation Debrief

Marginal Product =Change in Total Product

Change in Inputs

•Marginal Product (MP)- the additional output generated by additional inputs (workers).

•Total Physical Product (TP)- total output or quantity produced

•Average Product (AP)- the output per unit of input

Average Product =Total Product

Units of Labor

Production Analysis•What happens to the Total Product as you hire more workers?•What happens to marginal product as you hire more workers?•Why does this happens?

The Law of Diminishing Marginal ReturnsAs variable resources (workers) are added to fixed resources (machinery, tool, etc.), the

additional output produced from each new worker will eventually fall.

Too many cooks in the kitchen!