Lecture%204 - Econ 208 Lecture 4 Lecture 4 Utility and...

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Econ 208 Lecture 4 Lecture 4: Utility and Demand Intrepretation vs explanation Unlike wealth and profits, which we think motivate suppliers, utility is not observable.. The marginal utility theory of demand is an interpretation of the downward sloping demand curve. The downward slope is as if households or individuals were maximizing a utility function for which the marginal utility of any particular good diminishes with the quantity consumed. Let’s review the argument before proceeding. 1. Goods are conceived as contributing ‘utility,’ which is the actual final good that people desire. 2. Different goods contribute to that utility. Most are substitutes for each other, in the sense that if a person consumes less of one good, and thus obtains less utility from it, she can make up the utility loss by consuming more of another good. It is in this sense that we think of most goods as being substitutes. 3. There is a smaller class of goods that ‘go together,’ like bread and butter, sugar and tea, and eggs and bacon. What we consume is not the good singly, but in combination with some other goods. Such goods are known as complements . We shall return to the distinction between substitutes and complements shortly. But first the analysis of household equilibrium. Consider a household with a fixed amount of money to spend. Each of the goods it purchases adds a certain amount of ‘utility’ to that household. This relation allows us to define the marginal utility of a particular good as the change in total utility/the change in quantity of that good consumed.
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Econ 208 Lecture 4 Thus, if 9 apples yields 90 units of utility and 10 apples yields 100, the marginal utility of an apple, conditional on consuming 10 apples, is 10. Does utility measure the value of the ‘last’ unit purchased and consumed? This point is commonly asserted because it seems natural. We don’t get to the 10 th apple until we have already purchased nine. It seems reasonable, but it is wrong. Think of it this way: a basketball game is decided by one point, the winning team sinking the ‘winning’ goal in the last second of the game. Is the victory attributable to that baskiet? Most people would say yes, but the answer is no. The last basket added two points, but so did the first, second, third, etc. baskets. Take any of those baskets away, and the game goes the other way. There is no way that the last basket is the ‘cause’ of the victory. It is a necessary, but not sufficient condition. All the baskets are interchangeable, or as we would say in economics fungible.
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