Econ 201 1st Edition Lecture 12Outline of Last Lecture I. Explicit and Implicit CostsII. ProfitIII. Cost of CapitalIV. Decision MakingV. Behavioral EconomicsVI. IrrationalityOutline of Current LectureI. Utility and ConsumersII. Diminishing Marginal UtilityIII. Comparing Two Items by UtilityCurrent LectureRational Consumer-How do rational consumers choose what to spend their money on?Utility and Consumers-Some assumptions that will help:1. All goods have utility.- Utility: value or satisfaction from consumption.2. There is no saving. Consumers spend all income (ignore future consumption for now).3. Marginal utility diminishes over time.- Marginal utility (MU): the change in utility from consuming an additional unit.- Diminishing marginal utility: Each additional unit of a good adds less to utility than the previous unit.Diminishing Marginal Utility-Even cupcakes have diminishing marginal utility: The more you eat of them, the less happy they make you-Practice Question: Assume that the marginal utilities for the first three units of a good consumed are 200, 150, and 125, respectively. The total utility when two units are consumed is:Answer: 350How to Compare Two Items (Gumballs vs Icecream)-Since most decisions are made at the margin, we’ll need to know:- How much extra utility (MU) will you get from spending your next dollar on gumballs? On ice cream?- We are looking to maximize the utility per dollar spent.These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- Marginal Utility / Price per gumball or ice cream = utility per dollar spentComparing Marginal Utility to Price-The general rule: Compare the MU and the price for all goods, and then adjust your spending toward the goods that give you more MU per dollar.Optimal Consumption Bundle-The optimal consumption bundle is the one that maximizes a consumer’s total utility given his or her budget constraint.-At the optimal consumption bundle, the marginal utility per dollar spent on one item is equal to the marginal utility per dollar spent on the other item.-To maximize total utility, a consumer should allocate income so that the marginal utility per dollar is equal for all purchases.The Demand Curve-The optimal consumption rule explains why we buy less of something when its price rises (and vice versa).-Now we turn to the issue of budget: How do we maximize utility under a limited budget?-The budget constraint shows all of the consumption bundles that a consumer can afford given his or herincome and the prices. (We’ll simplify our world to two goods, clams and potatoes, for the sake of graphing.)-If Sammy’s income = $20, P(potato) = $2, and P(clam) = $4, we can figure out our consumption possibilities.-Make a chart of all of your options that take up all of your income, figure out how many utils you gain from each product, then make a total utility column and see which combination is most