Review
The state needs to raise money and it has a choice
of imposing an excise tax of the same amount on
one of two goods: restaurant meals or gasoline.
Both the demand and supply of restaurant meals
are more elastic than the demand and supply of
gasoline.
a. If the state wants to minimize the deadweight
loss, which good should be taxed?
b. For each good, sketch a diagram that illustrates
the deadweight loss from taxation.
Utility Maximization and
Consumer Choice
Module 51
Utility
How satisfied a person is with a transaction
• In many cases, we can look at $ values,
but in most cases we can’t measure it
that way
• Utils
– made-up units that represent satisfaction
– “Happy Points”
Utility Function
The relationship between a consumer’s utility and
the combination of goods and services he or she
consumes (consumption bundle)
• Marginal utility (MU)
– The additional satisfaction derived from consuming
one more of something
• Diminishing marginal utility
– Generally, as we consume more of a thing we derive
increasingly less satisfaction
Figure 51.1 Cassie’s Total Utility and Marginal Utility
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Budget Constraint
Consumers can’t spend more on goods
than their income – this is a constraint
• Consumption possibilities
– The set of consumption bundles that are
affordable at a given income level
• Budget line
– Kind of a consumer’s PPC!
Figure 51.2 The Budget Line
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Table 51.1 Sammy’s Utility from Clam and Potato Consumption
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Utility Maximization
The goal is to find the consumption bundle that
will provide the greatest total utility
• Optimal Consumption Bundle
– One way is to calculate total utility (in utils) for
every possible consumption bundle
Table 51.2 Sammy’s Budget and Total Utility
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Figure 51.3 Optimal Consumption Bundle
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Utility Maximization
Another way, is to look at the how much more
utility derives from each dollar spent
• Marginal Utility Per Dollar
MUgood
Pgood
Table 51.3 Sammy’s Marginal Utility per Dollar
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Figure 51.4 Marginal Utility per Dollar
Ray and Anderson: Krugman’s Economics for AP, First Edition
Copyright © 2011 by Worth Publishers
Utility Maximization
It turns out that utility is maximized at the
consumption bundle where the marginal utility
per dollar for each good is equal
• Optimal Consumption Rule
MuA
PA
=
MuB
PB
WHY?
As long as one good provides more utility per dollar
than another, the consumer will buy more of the
first good
As more of the first product is bought, its marginal
utility diminishes until the amount of utility per
dollar just equals that of the other product.
If we continue to buy more, the loss of utility from
the second product will outweigh the increase in
utility from the first
Problems
Use the concept of marginal utility to explain
the following:
Newspaper vending machines are designed to
stay open so that once you have paid for one
paper, you could take more than one paper at a
time. But soda vending machines, once you have
paid for one soda, dispense only one soda at a
time.
Problems
Assume you have an income of $100. The price of
good X is $5, and the price of good Y is $20
a. Draw a correctly labeled budget line
b. At a given consumption bundle, you receive 100
utils from consuming your last unit of good X
and 400 utils from consuming you last unit of
good Y. Are you maximizing your utility? Explain.
c. What will happen to the total and marginal
utility you receive from consuming good X if you
decide to consume another unit of good X.
Explain.