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u u(q1 , q2 , q3 , , qn )
u represents utility
qj is the quantity consumed of the jth good
(q1, q2, q3, . . . qn) is the consumption bundle
n is the number of goods and services available to the consumer
Marginal utility
Marginal utility is defined as the
increment in utility
an individual enjoys from consuming
an additional unit of a good or service.
u ( q1 , q2 , q3 , , qn )
MUqj MUj
qj
If you are familiar with calculus, marginal utility is
u(q1 , q2 , q3 , , qn )
MUqj
qj
q2
4
utility
8.00
10.08
11.54
12.70
13.68
14.54
15.31
16.00
16.65
10
17.24
11
17.80
12
18.32
marginal utility
2.08
1.46
1.16
0.98
0.86
MU1
0.77
0.69
0.65
0.59
0.56
0.52
u
q1
16.65 16
9 8
0.65
Marginal utility
Marginal utility
3.0
2.5
mu1(q1,q2=3)
2.0
1.5
1.0
0.5
0.0
10
12
q1
14
q1 , q2 , q3 , , q n
[ u( q1 , q2 , q3 , , qn ) ]
subject to
p1 q1 p2 q2 p3 q3 pn qn I
As the consumer chooses more of a given good,
utility will rise,
but because goods cost money, the consumer
will have to consume less of another good
because expenditures are limited by income.
subject to
p1 q1 p2 q2 I
Notation
u - utility
Income - I
Quantities of goods - q1, q2, . . . qn
Prices of goods - p1, p2,. . . pn
Number of goods - n
Why?
Not Affordable
Affordable
1
q2
q2
Utility
11.00
11.85
12.59
11.54
12.70
13.68
14.54
14.20
15.30
16.26
Marginal
Utility
0.74
1.16
0.85
0.98
0.86
1.10
0.96
p1 = 5
p2 = 10
I = 50
q1 = 2
q2 = 4
(5)(2) + (10)(4) = 50
q1 = 4
q2 = 3
(5)(4) + (10)(3) = 50
q1 = 6
q2 = 2
(5)(6) + (10)(2) = 50
Budget Constraint
p1 = 5
11
q1 10
9
8
7
6
5
4
3
2
1
0
p2 = 10
I = 50
(6,2)
(4,3)
(2,4)
q1
6
q2
2
utility
10.280
2
4
4
3
10.080
10.998
q2
Exp = I = 50
Exp = I = 50
Exp = I = 50
Indifference Curves
An indifference curve represents
all combinations of two categories of goods
that make the consumer equally well off.
q2
1
2
3
4
5
utility
8
8
8
8
8
Graphical analysis
Indifference Curve
14
q1 12
10
8
u=8
6
4
2
0
0
q2
q1
15.625
8
q2
1
1
utility
10.00
8.00
q1
15.625
5.524
3.007
1.953
1.398
1.063
0.844
q2
1
2
3
4
5
6
7
utility
10.00
10.00
10.00
10.00
10.00
10.00
10.00
u = 10
q2
u=8
u = 10
u = 12
u = 15
q2
Indifference Curves
20
q1 18
16
14
12
10
8
6
4
2
0
u = 12
q2
Indifference Curves
20
q1 18
16
14
12
10
8
6
4
2
0
u = 12
q2
u = 12
q2
MRSq1, q2
q1
u constant
q2
Example calculations
q1
5.524
3.007
1.953
1.398
1.063
q2
2
3
4
5
6
utility
10.00
10.00
10.00
10.00
10.00
Change q2 from 4 to 5
MRSq , q
1
q1
q2
u constant
1.953 1.398
4 5
0.555
0.555
1
Example calculations
q1
5.524
3.007
1.953
1.398
1.063
q2
2
3
4
5
6
utility
10.00
10.00
10.00
10.00
10.00
Change q2 from 2 to 3
MRSq1, q2
q1
u constant
q2
5.524 3.007
2 3
2.517
2.517
1
Indifference Curves
40
q1 35
30
25
20
15
10
5
0
u = 10
Give up lots of q1 to get 1 q2
-2.517
Give up a little q1
to get 1 q2
2
-0.555
q2
u = 10
-0.555
5 q2 6
40
q1 35
30
25
20
15
10
5
0
-2.517
q1
5.524
3.007
1.953
q2
2
3
4
utility
10.00
10.00
10.00
u = 10
-2.517
q2
-10.101
u = 10
q2
Break
Budget Lines
Indifference Curves
18
q1 16
14
12
10
8
6
4
2
0
q1
8
2.828
3.007
4
3.375
q2
1
2
3
3
4
cost
50.00
34.14
45.04
50.00
56.88
utility
8.000
8.000
10.000
10.998
12.000
u=8
u = 10
u = 12
Budget Line
6
q2
14
12
10
8
6
4
2
0
u=8
Budget Line
6 q2 7
The point (3, 3.007) will give a higher utility level of 10,
but there is still some income left over
18
q1 16
14
12
10
8
6
4
2
0
q1
8
2.828
3.007
q2
1
2
3
cost
50.00
34.14
45.04
utility
8.000
8.000
10.000
u=8
u = 10
Budget Line
6
q2
18
q1 16
14
12
10
8
6
4
2
0
q2
1
2
3
3
cost
50.00
34.14
45.04
50.00
utility
8.000
8.000
10.000
10.998
u=8
u = 10
Budget Line
6
q2
The point (4, 3.375) will give an even higher utility level
of 12, but costs more than the $50 of income.
q1
8
2.828
3.007
4
3.375
18
q1 16
14
12
10
8
6
4
2
0
q2
1
2
3
3
4
cost
50.00
34.14
45.04
50.00
56.88
utility
8.000
8.000
10.000
10.998
12.000
u=8
u = 10
u = 12
Budget Line
q2
15
10
5
0
40
30
20
10
0
6
q1
10
12
14
40
30
20
10
0
20
4
6
q1
15
8
10
10
q2
12
5
14
0
Contour lines
20
q2
15
10
0
0
10
q1
15
20
Function
40
30
20
10
0
20
4
6
q1
15
8
10
10
q2
12
5
14
0
Contour lines
20
q2
15
10
0
0
10
q1
15
20
p 1q 1 + p 2 q 2 = I
5q1 + 10 q2 = 50
q1 = 10 - 2q2
0
0
2.5
5
7.5
10
2.5
7.5
10
q2
4
2
0
20
15
10
5
0
2.5
7.5
5
q1
10
Along the budget wall we can find the highest utility point
q1
5
10
20
15
10
5
0
6
4
2
0
q2
5
0
2.5
7.5
10
q1
All points at the height of the plane have the same utility
q1
2.5
5
7.5
10
20
15
10
5
0
6
4
2
0
q2
q2
4
2
0
20
15
HL
u q1, q2
10
5
0
2.5
7.5
5
q1
10
Another view
q1
5
10
20
15
10
5
0
6
4
2
0
q2
HL
u q 1, q2
q2
0
0
6
q1
10
Raise p1 to 10
8
q2
0
0
6
q1
10
Characteristics of an optimum
From observing the geometric properties of the optimum levels
of q1 and q2, the following seem to hold:
a.
b.
c.
d.
p2
p1
MRSq1 q2
Budget Line
0 1 2 3 4 5 6 7
q2
u = 10
Budget Line
0 1 2 3 4 5 6 7
q2
u=8
Budget Line
0 1 2 3 4 5 6 7
q2
q1
8
2.828
3.007
4
q2
1
2
3
3
cost
50.00
34.14
45.04
50.00
utility
8.000
8.000
10.000
10.998
q1 = 2.828 - 8 = -5.172
u=8
u = 10
Budget Line
0 1 2 3 4 5 6 7
q2
18
q1 16
14
12
10
8
6
4
2
0
u=8
u = 10.998
u = 10.28
Budget Line
Move down
q2
u=8
u = 10
Budget Line
0 1 2 3 4 5 6 7
q2
u=8
u = 10
Budget Line
0 1 2 3 4 5 6 7
q2
18
q1 16
14
12
10
8
6
4
2
0
u=8
u = 10
u = 10.998
Budget Line
q2
0 1 2 3 4 5 6 7
q2
18
q1 16
14
12
10
8
6
4
2
0
u = 10
u = 10.998
q2
u( q1 , q2 , q3 , , qn )
MUqj MUj
qj
MUq1 q1 MUq2 q2 0
MUq q2
q1
MUq1
q1
q2
MUq
MUq
MRS q1 q2
q1
q2
MUq
MUq1
MRS q1 q2 MRS 12
q1
q2
MUq2
MUq
Optimality conditions
p2
MRSq1 q2
p1
Substituting we obtain
p2
p1
MRSq1 q2
p2
p1
q1
q2
MUq2
MUq1
MUq2
MUq
p2
p1
MUq2
MUq1
MUq1 p2
p1
MUq2
MUq1
p1
MUq2
p2
Interpretation ?
The marginal utility per dollar for each good
must be equal at the optimum point of consumption.
MUq1
p1
MUq2
p2
Example
p1 = 5
q2
0
1
2
3
4
5
q1
10
8
6
4
2
0
p2 = 10
u
0.000
8.000
10.280
10.998
10.080
0.000
MU1
0.000
0.334
0.572
0.917
1.680
I = 50
MU2
4.000
2.570
1.833
1.260
0.000
MU1/p1
0.000
0.067
0.115
0.184
0.336
MU2/p2
0.4
0.257
0.184
0.126
0.000
Budget Constraint
p1 = 5
p2 = 10
I = 50
11
q1 109
8
7
6
5
4
3
2
1
0
Budget Line
2
3
4
q2
q2 q1 u
0 10 0.000
1 8 8.000
MU1
0.000
0.334
0.000
q2
0
1
2
q1
10
8
6
u
0.000
8.000
10.280
MU1
0.000
0.334
0.572
MU2
4.000
2.570
MU1/p1 MU2/p2
0.000
0.067
0.4
0.115
0.257
Consider q2 = 1 and q1 = 8.
The marginal utility (per dollar) of an additional unit
of q1 is 0.067,
while the utility of an additional unit (per dollar)
of q2 is 0.4
Thus we should clearly move to the point q2 = 2, q1 = 6
q2
0
1
2
3
q1
10
8
6
4
u
0.000
8.000
10.280
10.998
MU1
0.000
0.334
0.572
0.917
MU2
4.000
2.570
1.833
MU1/p1
0.000
0.067
0.115
0.184
MU2/p2
0.4
0.257
0.184
q1
10
8
6
4
2
0
u
0.000
8.000
10.280
10.998
10.080
0.000
MU1
0.000
0.334
0.572
0.917
1.680
MU2
4.000
2.570
1.833
1.260
0.000
MU1/p1
0.000
0.067
0.115
0.184
0.336
MU2/p2
0.4
0.257
0.184
0.126
0.000
And we stop!
The End
u=8
u = 10
Budget Line
0 1 2 3 4 5 6 7
q2
0 1 2 3 4 5 6 7
q2
0 1 2 3 4 5 6 7
q2