Chapter 10 Utility Getting Satisfaction Utility and Consumption o Utility an individual s personal measure of satisfaction gained from consumption of goods and services We use utility to understand behavior but don t expect to measure in practice The assumption that consumers maximize utility helps us think clearly about consumer choice o Consumption bundle the set of all the goods and services an individual consumes o Utility function the relationship between an individual s consumption bundle and the total amount of utility it generates for that individual Two people with different tastes will have different utility functions Consumers use consumption to produce utility for example consuming which product will give me the most utility This is like a producer choosing which product will make him more revenue for the same amount of inputs When deciding between products people decide the one which will give them the most utility this is based more on intuition and preference than math o Util a unit of utility o When looking at someone s utility function the function can increase but then increases less and less in the case of figure 10 1 pg 271 consuming the 9 th clam will actually decrease utility This shows that you must look at consumption on a unit by unit basis adding the 8th clam will give you more utility but not as much as when you added the 7th and adding the 9th will actually decrease utility This happens because even though you love clams you eventually become full or get tired of the taste Finally you re so full or tired that eating another will actually hurt your happiness or utility To maximize total utility consumers must focus on marginal utility The Principle of Diminishing Marginal Utility o Marginal utility the change in total utility from consuming one additional unit o Marginal utility curve a graph of the marginal utility see figure 10 1 page 271 Constructed by plotting points at the midpoint of the unit intervals Slopes downward each successive unit adds less to the total utility than the previous unit The consumption of most goods and services are subject to diminishing marginal utility o The Principle of Diminishing Marginal Utility the additional satisfaction a consumer gets from one more unit of a good or service declines as the amount of that good or service consumed rises Budgets and Optimal Consumption Budget Constraints and Budget Lines o Because the true cost of something is its opportunity cost and a consumer only has limited money choosing to buy one more of one product means choosing to buy less of another o When looking at how much of each particular good to buy it is obvious that an individual s consumption bundle cannot exceed his income So there is a limit to how much of each good he likes that he can buy Expenditure on Good A Expenditure on Good B Expenditure on all other Goods Total income o Consumers always have limited income which limits how much they can consume Budget Constraint a consumer must choose a consumption bundle that costs no more than his or her income Consumption bundles are affordable as long as they obey the budget constraint o Consumption possibilities the set of all an individual s affordable consumption bundles This includes everything on the budget line as well as underneath the budget line although everything underneath the line is not efficient it is still affordable o Budget Line the line created when graphing all of an individual s efficient consumption bundles it represents all the possible combinations of goods that can be consumed as well as acts as a boundary between possible and impossible consumption bundles Anything above the line is impossible with the current income Anything below is affordable but does not use up all the income When moving between points on the budget line consuming more of one good means consuming that much less of another this is not necessarily true underneath the budget line because points underneath the line are not efficient o How a budget constraint changes An increase in income shifts the budget constraint outward a decrease in income will therefore shift the line inward toward zero A change in price of one or more of the goods chosen from will change the slope of the budget constraint o But if all points on the budget line are technically equal in terms of price how do you decide which to choose The answer is individual preferences Optimal Consumption Choice o Optimal consumption bundle the consumption bundle that maximizes that individual s total utility o o You can figure out the utility of each quantity of product A and the utility of each quantity of product B Adding the utilities of both across the row gives the total utility of each consumption bundle allowing you to easily see which gives the most total utility o In this case consumption bundle C has the highest total utility and therefore is the optimal consumption bundle If you graphed the total utility curve bundle C would be the highest point on that curve visually showing that it is the optimal choice Spending the Marginal Dollar Even though you can see the optimal consumption bundle by looking at its graph it is more precise to find it by marginal analysis The marginal decision is a question of how to spend the marginal dollar how to allocate an additional dollar between product A and product B in a way that maximizes utility The marginal utility per dollar spent on a good or service is the additional utility from spending one more dollar on that good or service o To find the marginal utility per dollar simply divide the marginal utility of the good by its price in dollars o MU per dollar MU of one unit of product A Price of one unit of product A o Do the same for product B then compare the MU per dollar for each good o Optimal consumption bundle found when comparing MU per dollar When MU per dollar of product A MU per dollar of product B buy more of product B and less of A When MU per dollar of product A MU per dollar of product B buy more of product A and less of B When MU per dollar of product A MU per dollar of product B this is the optimal consumption bundle o Utility maximizing principle of marginal analysis to maximize total utility a consumer should allocate income so that the marginal utility per dollar is equal for all purchases o In consumption decisions unlike production decisions a budget constraint must be accounted for you can borrow money and other capital to produce more but you are constrained in