# 2010fa16wk05notesHandout - 2010-001 Fall 2016 General Info...

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2010-001 Fall 2016 General InfoContact with reality2010-001 Fa 16 Week 04Chapter 7 – Utility MaximizationLearning ObjectivesLO7.1 Define and explain the relationship between total utility,marginal utility, and the law of diminishing marginal utility.LO7.2 Describe how rational consumers maximize utility bycomparing the marginal utility-to-price ratios of all theproducts they could possibly purchase.LO7.3 Explain how a demand curve can be derived byobserving the outcomes of price changes in theutility-maximization model.LO7.4 Discuss how the utility-maximization model helpshighlight the income and substitution effects of a price change.LO7.5 Give examples of several real-world phenomena thatcan be explained by applying the theory of consumerbehavior.LO7.6 (Appendix) Relate how the indifference curve model ofconsumer behavior derives demand curves from budget lines,indifference curves, and utility maximization.7-2 Law of Diminishing Marginal Utility Law of diminishing marginal utility As consumption of a good or service increases, the marginal utility obtained from each additional unit of a good or service decreases Explains downward sloping demand curve LO1 7-3 Terminology Utilityis the satisfaction one gets from consuming a good or service Not the same as usefulness Subjective Difficult to quantify LO1 7-4 Total Utility and Marginal Utility Util is one unit of satisfaction or pleasure Total utility is the total amount of satisfaction Marginal utility is the extra satisfaction from an additional unit of the good MU = ΔTU/ΔQ LO1
7-5 Total Utility and Marginal Utility 0 10 20 30 10 8 6 4 2 0 -2 1 2 3 4 5 6 7 1 2 3 4 5 6 7 Total utility (utils) Marginal utility (utils) (2) Total Utility, Utils (3) Marginal Utility, Utils 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 TU (1) Tacos Consumed Per Meal MU ] ] ] ] ] ] ] LO1 7-6 Theory of Consumer Behavior Rational behavior Preferences Budget constraint Prices LO2 7-7 Utility Maximizing Rule Consumer equilibrium Consumer allocates his or her income so that the last dollar spent on each product yields the same amount of extra (marginal) utility Algebraically, MU of product A MU of product B Price of A Price of B = LO2 7-8 Numerical Example LO2 The Utility Maximizing Combination of Apples and Oranges Obtainable with an Income of \$10 (2) Apple (Product A): Price = \$1 (3) Oranges (Product B): Price = \$2 (1) Unit of Product (a) Marginal Utility, Utils (b) Marginal Utility per dollar (MU/Price) (a) Marginal Utility, Utils (b) Marginal Utility per dollar (MU/Price) First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2
7-9 Decision-Making Process LO2 Sequence of Purchases to Achieve Consumer Equilibrium Choice Number Potential Choices Marginal Utility per Dollar Purchase Decision Income Remaining 1 First Apple First Orange 10 12 First orange for \$2 \$8 = \$10 - \$2 2 First Apple Second Orange 10 10 First apple for \$1 and Second orange for \$2 \$5 = \$8 - \$3 3 Second Apple Third Orange 8 9 Third orange for \$2 \$3 = \$5 - \$2 4 Second Apple