chapter_05 - 6 1 Learning Outcomes 6 2 Marginal utility is...

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1 6- 1 DEMAND ANALYSIS I: MARGINAL UTILITY Slides by Alex Stojanovic with additions by Winston Moore 6- 2 Learning Outcomes Marginal utility is a key concept underlying demand theory Market price depends on marginal rather than total utility Marginal utility of each product diminishes as additional units are consumed The negative slope of the demand curve is linked to diminishing marginal utility When a consumer has allocated her funds in the best way she can, the marginal utility of each $ worth of spending will be the same for all goods purchased Elasticity of demand depends on marginal, not total utility 6- 3 Marginal and Total Utility • The satisfaction a consumer receives from consuming a product is called utility. • Total utility therefore refers to the total satisfaction derived from all the units of that product consumed. • Marginal utility refers to the change in satisfaction resulting from consuming one unit more or one unit less of that product. 6- 4 Assumptions • Utility theory assumes that the consumer can attach numerical values to her satisfaction. • The theory also assumes that individuals attempt to maximise their personal utility or satisfaction independently of others. • The model also assumes (sometimes also referred to as the law of diminishing marginal utility) that the marginal utility, generated by additional units of any product diminishes as an individual consumes more of it, holding constant the consumption of all other products. 6- 5 The Law of Diminishing Marginal Utility • This law can be illustrated using a simple example: – Consider the consumption of water – If you did not have water for the entire day, you would gladly give up a significant amount of money for a few units. Thus the total utility of water is very high, as is the first few units. – After consuming this minimum amount necessary to sustain life, however, the marginal utility of successive amounts of water consumed declines steadily over any period of time. 6- 6 Total and Marginal Utility Schedules Number of films attended per month Total utility 0 1 3 4 2 10 6 7 5 9 8 0.00 15.00 25.00 31.00 35.00 37.50 10.00 4.00 2.50 1.25 0.90 0.80 Marginal utility 39.00 40.25 41.30 42.20 43.00 15.00 6.00 1.05 1.5
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2 6- 7 As consumption increases, total utility rises but marginal utility falls. The marginal utilities are the changes in utility when consumption is altered by one unit. For example, the marginal utility of the 2 nd film, shown in the entry in the last column, arises because with attendances at the second film total utility increase from 15 to 25 a difference of 10. Total and Marginal Utility Schedules 6- 8 2 4 6 8 10 10 20 30 40 50 Total and Marginal Utility Curves [i]. Increasing total utility [ii]. Diminishing marginal utility Quantity of films [attendance per month] 15 10 5 Utility [$] 20 0 2 4 6 8 10 0 6- 9 Maximising Utility • Equilibrium for one product
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chapter_05 - 6 1 Learning Outcomes 6 2 Marginal utility is...

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