UTILITY

# UTILITY - THE LOGIC OF CONSUMER CHOICE UTILITY THEORY...

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THE LOGIC OF CONSUMER CHOICE UTILITY THEORY Diamond-Water Paradox The observation that those things that have the greatest value in use sometimes have little value in exchange and those things that have little value in use sometimes have the greatest value in exchange. H 2 O is necessary to life and diamonds are not. H 2 O is cheap and diamonds are expensive. Isn’t it odd, paradoxical? This is the question that the economist Adam Smith wondered about. Utility A measure of the satisfaction, happiness or benefit that results from the consumption of a good. To say that a good gives you utility is to say that it has the power to satisfy wants or that it gives you satisfaction. Util An artificial construct used to measure utility. Total Utility(TU) The total satisfaction a person receives from consuming a particular quantity of a good. Marginal Utility(MU) The additional utility a person receives from consuming an additional unit of a particular good. MU = ∆TU ∆Quantity TU X X MU MU TU

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The Law of Diminishing Marginal Utility The MU gained by consuming equal successive units of a good will decline as the amount consumed increases. Utility and the Game of Chess Sometimes one derives more utility form something as you get better at it. Does this invalidate the law of diminishing MU? Take for example the game of chess, golf, tennis, etc. Some economists talk of a principle of diminishing marginal utility rather than a law while others talk of an exception to the law. William Stanley Jevons - The MU associated with consuming equal successive units of a good will eventually decline as the amount consumed increases. THE MILLIONAIRE AND THE PAUPER Does a poor man get more or less utility from one more dollar than a millionaire does? Interpersonal Utility Comparison Comparing the utility one person receives from a good, service or activity with the utility another person receives from the same good, service or activity. THE SOLUTION TO THE DIAMOND-WATER PARADOX The TU of H 2 O is high because H 2 O is extremely useful The TU of diamonds is low because diamonds are not as useful as H 2 O The MU of H 2 O is low because H 2 O is so plentiful The MU of diamonds is high because diamonds are so scarce
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## This note was uploaded on 01/28/2011 for the course ECON 1 taught by Professor Sm during the Spring '10 term at Laney College.

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UTILITY - THE LOGIC OF CONSUMER CHOICE UTILITY THEORY...

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