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Analysis of UTILITY
Learning objectives
Total Utility, Marginal Utility, and the Law of Diminishing
Marginal Utility
How Rational Consumers Compare Marginal Utility-to-Price
Ratios for Products in Purchasing Combinations to Maximize
Total Utility
How to Derive the Demand Curve by Observing Behavior
How the Utility-Maximization Model Highlights Income and
Substitution Effects of a Price Change
MARGINAL UTILITY
THEORY
Utility Theory
Utility
Utility Analysis
Util
MARGINAL UTILITY
THEORY
Utility
Temperature: An Analogy
The concept of utility helps us make predictions
about consumption choices in much the same
way that the concept of temperature helps us
make predictions about physical phenomena.
MARGINAL UTILITY
THEORY
Total Utility
MARGINAL UTILITY
THEORY
Marginal Utility
Marginal utility =
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
]
]
]
]
]
]
]
10
8
6
4
2
0
-2
Total Utility
30
TR
20
10
0
Marginal Utility
10
8
6
4
2
0
-2
MU
1
Constraint
Rational Behavior
Preferences
Budget Constraint
Prices
Utility
Maximizing Rule
Theory
of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products A and B
Obtainable with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
(3)
Product B:
Price = $2
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
First
10
10
24
Second
8
8
20
Third
7
7
18
Compare Marginal Utilities
Fourth
6
6
16
Then Compare Per Dollar - MU/Price
Fifth
5
5
12
Choose the Highest
Sixth
4
4
6
Check Budget - Proceed to Next Item
Seventh
3
3
4
12
10
9
8
6
3
2
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable
with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
First
10
10
Second
8
8
Third
7
7
Again, Compare Per Dollar - MU/Price
Fourth
6
6
Choose the
Highest
Fifth
5 Has $5
5 Left
Buy One of
Each Budget
Proceed to
Next Item 4
Sixth
4
Seventh
3
3
(3)
Product B:
Price = $2
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable
with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
First
10
10
Second
8
8
Third
7
7
Fourth
6
6
Again, Compare Per Dollar - MU/Price
FifthB Budget
5 Has $35 Left
Buy One More
4
Proceed toSixth
Next Item 4
Seventh
3
3
(3)
Product B:
Price = $2
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
Theory of Consumer
Numerical Example:
Utility-Maximizing
Combination of Products A and B Obtainable
Behavior
with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
First
10
10
Second
8
8
Third
7
7
Fourth
6
6
Fifth
5
5
Again, Compare Per Dollar - MU/Price
Sixth
4
4
Buy One of Each Budget Exhausted
Seventh
3
3
(3)
Product B:
Price = $2
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable
with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
(3)
Product B:
Price = $2
(b)
Marginal
(a)
Utility
Marginal
Utility, Per Dollar
Utils (MU/Price)
First
10
10
Second
8
8
Third
7
7
Fourth
6
6
Fifth
5
5
Final Result At These Prices, Purchase 2
Sixth
4
4
4 of B
Seventh
3
3
24
12
20
10
18
9
16
8
12
6
of Item A and
6
3
4
2
MU of Product A
Price of A
8 Utils
$1
=
=
MU of Product B
Price of B
16 Utils
$2
MARGINAL UTILITY
THEORY
MARGINAL UTILITY
THEORY
MARGINAL UTILITY
THEORY
$2
1
Quantity
Demanded
4
6
Income Effects
Price of Product B
DB
0
Quantity Demanded of B
Applications and
Extensions
MARGINAL UTILITY
THEORY
MARGINAL UTILITY
THEORY
MARGINAL UTILITY
THEORY
Consumer Efficiency
27
The Diamond-Water
Paradox
28
The
consumer
surplus
from
diamonds is the
small
blue
triangle.