The Rational Consumer

• The income and substitution effects have been sacrificed… Their definitions are straight forward and in your book

Most Relevant Terms• Utility-The satisfaction a consumer gets from a

good or service… “want-satisfying power”• Total Utility-Total amount of satisfaction derived

from the consumption of a single product or a combination of product

• Marginal Utility-The extra utility a consumer obtains from consuming 1 addition unit of a good or service…

Marginal Utility= Total Utility Change in Quantity Consumed

LAW/PRINCIPLE OF DIMINISHING MARGINAL UTILITY

This is as foundational to economics as anything else… There are an infinite amount of examples and it also determines the downward nature of the demand curve

• As a consumer increases their consumption of a good or service, the MU gained from each additional good decreases

This is Cassie’s Total Utility and Marginal Utility curves that correlate to previous table…

Leave room so we can graph more of it

Clarifying questions

• When MU=0, what is the TU curve doing?

• Could TU ever be negative?

MU and Downward Demand

As a consumer gets less utility for each additional good, that means they will only consume more if the price is lower... That is the requisite of balancing out a decline MU

THIS IS CLOSELY TIED TO THE LAW OF DEMAND

The ECON Cheer

http://www.youtube.com/watch?v=5cO8PamOiCM

Depressing…

I AM LAYING DOWN THE GAUNTLET!

elastICITYThe rule:When demand is more price elastic, MU changes slowly

When demand is more price inelastic, MU changes sharply

You can tell this by the change of price… If price changes falls dramatically with an increase in quantity, that means the consumer’s small MU is being compensated by the lower price

Utility Maximization Rule

The consumer should allocate his or her money income so that the last dollar spent on each product yields the same amount of marginal utility

Utility Maximization Rule

The consumer should allocate his or her money income so that the last dollar spent on each product yields the same amount of marginal utility

We will be investigating utility maximization when it comes to two items

(YOU ARE WELCOME!)

Utility Maximization Rule

Just like S&D equilibrium is the “market-clearing” price and quantity, when utility is maximized the consumer’s “margins are balanced”… Meaning they will continue to consume the maximizing bundle of both goods

Utility Per DollarWhen deciding which bundle of the two goods you will consume, you also must take the price into account along with the MU. This is because you have a budget and what you are paying for one will determine how much of the other you can buy. You must compare MU with its added price

If you get 100 utils from having a certain shirt that costs $25 but 50 utils for a pair of shoes that cost $10. Which one would a rational consumer prefer? (marginal utility per dollar)

Unit of Product MUA MUA/PriceA MUB MUB/PriceB

First 40 10 25 5

Second 32 8 21 5.2

Third 20 5 15 3

Fourth 16 4 10 2

Fifth 12 3 5 1

Pick the one where they are equal

Product A: Price=$4 Product B: Price=$5

If you have two products, let’s say C and P, you will choose the bundle in which the following is true:

Algebraic Restatement

Example 1:

Unit of Product MUA MUA Per $ MUB MUB Per $

First 120 10 90 15

Second 60 5 54 9

Third 54 4.5 24 4Fourth 48 4 12 2

Fifth 36 3 6 1

Help Ryan and Tori decide how to spend their $76 to maximize their utility. They would just bicker. How much of each product should they consume?

Product A: Price=$12 Product B: Price=$6

Law of Demanded Revisited

As shown on page 400-401, when price decreases you will demand a higher quantity if

you want to have utility equilibrium.

The Diamond-Water Paradox

Why is it essential goods are so much cheaper than unimportant ones?

Here, you must distinguish between total utility and marginal utility. Water has high total utility but low marginal utility. As it is comparatively (to diamonds) plentiful, it is also cheaper. The MU of diamonds is higher…