Warm-up: October 3, 2016
What is marginal utility? What is utility for that matter?
Use the concept of marginal utility to explain the
following: Newspaper vending machines are
designed so that once you have paid for one paper,
you can 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.
The Rational Consumer (10/3)
I. Utility: Getting satisfaction
A. Utility: satisfaction gained from consumption
B. Consumption bundle: set of all goods and services
a person consumes
C. Utility function: relationship between consumption
bundle and total utility generated
D. Marginal utility: the change in total utility from
consuming one more unit
Cassie’s Total Utility and Marginal Utility
(a)Cassie’s Utility Function
Total
utility
(utils)
70
60
50
40
30
20
10
0
Marginal
utility per
clams
(utils)
16
14
12
10
8
6
4
2
0
–2
Utility
function
1
2
3
4
5
6
7
8
9
Quantity of clams
(b) Cassie’s Marginal Utility Curve
Marginal
Utility
Curve
1
2
3
4
5
6
7
8
9
Quantity of clams
0
Total
utility
(utils)
0
1
15
2
28
3
39
4
48
5
55
6
60
7
63
8
64
9
63
Quantity
of clams
Marginal
utility per
clam (utils)
15
13
11
9
7
5
3
1
–1
E. Principle of diminishing marginal utility:
1. Applies for vast majority of cases
1.
Explain why a rational consumer who has diminishing marginal
utility for a good would not consume an additional unit when it
generates negative marginal utility, even when that unit is free.
What might be an example of this?
2.
Marta drinks 3 cups of coffee a day, for which she has diminishing
marginal utility. Which of her 3 cups generates the greatest
increase in total utility? Which generates the least?
3.
In each of the following cases, does the consumer has
diminishing, constant, or increasing marginal utility?
a. The more Mabel exercises, the more she enjoys each
additional visit to the gym.
b. Although Mei’s CD collection is huge, her enjoyment from
buying another CD has not changed as her collection has
grown.
c. When Dexter was a struggling student, his enjoyment of a
good restaurant meal was greater than now, when he has
them more frequently.
II. Budgets and Optimal Consumption
A. Budget constraint: the cost of consumption
bundle cannot be more than consumer’s
income
B. Consumption possibilities: set of all
consumption bundles that can be consumed
given the consumer’s income and prevailing
prices
C. Budget line: all of the consumption bundles
available to a consumer who spends all of
his/her income
Sammy’s income = $20/week
Potatoes = $2/lb; clams = $4/lb
The Budget Line
Quantity of potatoes
(pounds)
Unaffordable
consumption bundles
10
A
8
B
6
C
4
2
Affordable
consumption
bundles that cost
all of Sammy's
income
Affordable
consumption
bundles
D
1
2
Quantity of
potatoes
(pounds)
A
0
10
B
1
8
C
2
6
D
3
4
E
4
2
F
5
0
E
Sammy’s Budget Line, BL
F
0
Consumption
bundle
Quantity
of clams
(pounds)
3
4
5
Quantity of clams (pounds)
The budget line represents all the possible combinations of quantities of potatoes and clams
that Sammy can purchase if he spends all of his income. It is also the boundary between the
set of affordable consumption bundles (the consumption possibilities) and unaffordable ones.
Practice Problem
The consumption bundle consists of movie tickets
and buckets of popcorn. Each ticket costs $10,
and each bucket of popcorn costs $5. The
consumer’s income is $40.
List the possible bundles, using all $40.
Don’t bother graphing it.
D. Optimal consumption choice
1. Total utility maximized given the budget
constraint
Sammy’s Budget and Total Utility
Sammy’s total utility is the sum of the utility he gets from clams and
the utility he gets from potatoes.
Optimal Consumption Bundle
(a) Sammy’s Budget Line
Quantity of
potatoes
(pounds) 10 A
B
8
The optimal
consumption
bundle…
C
6
D
4
E
2
0
1
2
3
F BL
4
5
Quantity of clams (pounds)
(b) Sammy’s Utility Function
Total
utility
(utils) 80
70
A
60
50
40
30
20
10
B
C
D
E
… maximizes total utility
given the budget
constraint
0
1
10
8
2
3
4
Quantity of clams (pounds)
2
6
4
Quantity of potatoes (pounds)
Utility
function
F
5
0
Sammy’s total utility is
maximized at bundle C,
where he consumes 2
pounds of clams and 6
pounds of potatoes. This is
Sammy’s optimal
consumption bundle.
Food for Thought on Budget Constraints
• Budget constraints aren’t just about money. In fact, there are
many other budget constraints affecting our lives.
• Examples are:
– Limited amount of closet space for clothes.
– A fixed number of hours in a day.
– A dieter on the Weight Watchers plan is only allowed a
maximum number of points regarding the food they can eat
each day whereby each food is assigned a certain number of
points.
• The dieter is just like a consumer choosing a consumption
bundle: points are the equivalent of prices, and the overall
point limit is the equivalent of total income.
III. Spending the Marginal Dollar (3/15)
A. Marginal utility per dollar: how much add’l
utility one gets from spending an add’l dollar on
either good
Marginal Utility per Dollar
Total utility (utils)
If Sammy has, in
fact, chosen his
optimal
consumption
bundle, his marginal
utility per dollar
spent on clams and
potatoes must be
equal.
MU / P
P P
At the optimal consumption bundle, the
marginal utility per dollar spent on clams
is equal to the marginal utility per dollar
spent on potatoes.
6
5
4
B
C
3
C
2
1
MU
B
P
C
0
1
2
3
Quantity of clams (pounds)
4
5
10
8
6
4
Quantity of potatoes (pounds)
2
0
/P
C
B. The rule: Marginal analysis solves “how much”
decisions by setting the marginal benefit of some
activity equal to its marginal cost.
Bernie spends his income on notebooks and Beyonce CDs.
(save some room on the right side of each table)
Quantity of
notebooks
Utility from
notebooks
Quantity of
CDs
Utility from
CDs
0
0
0
0
2
70
1
80
4
130
2
150
6
180
3
210
8
220
4
260
10
250
5
300
The price of a notebook is $5, the price of a CD is $10, and
Bernie has $50 to spend.
a. Which consumption bundles can Bernie consume if he
spends all his money?
b. Calculate total utility for each consumption bundle.
What is Bernie’s optimal consumption choice?
c. For each product, add a “marginal utility” and “marginal
utility per dollar” column to your charts.
d. Graph the marginal utilities per dollar spent for each
product. What is Bernie’s optimal consumption level?
0 notebooks, 5 CDs = 300 total utils
2 notebooks, 4 CDs = 330 total utils
4 notebooks, 3 CDs = 340 total utils
6 notebooks, 2 CDs = 330 total utils
8 notebooks, 1 CD = 300 total utils
10 notebooks, 0 CDs = 250 total utils
Notebooks
CDs
Quantity
TU
MU
0
0
2
70
35
4
130
6
MU/P
Quantity
TU
MU
MU/P
0
0
7
1
80
80
8
30
6
2
150
70
7
180
25
5
3
210
60
6
8
220
20
4
4
260
50
5
10
250
15
3
5
300
40
4
What if Bernie was currently buying 2 notebooks and 4 CDs? How
should he alter his consumption maximize utility?
Mrs. Johnson spends her entire daily budget on potato chips, at a price of $1 each,
and onion dip at a price of $2 each. At her current consumption bundle, the marginal
utility of chips is 12 utils and the marginal utility of dip is 30 utils. Mrs. Johnson should
(A) do nothing; she is consuming her utility maximizing combination of chips
and dip
(B) increase her consumption of chips until the marginal utility of chip
consumption equals 30
(C) decrease her consumption of chips until the marginal utility of chip
consumption equals 30
(D) decrease her consumption of chips and increase her consumption of dip
until the marginal utility per dollar is equal for both goods
(E) increase her consumption of chips and increase her consumption of dip
until the marginal utility per dollar is equal for both goods
Dorothy has a daily income of $20, each cup of coffee costs $1 and each scone
costs $4. The table below provides us with Dorothy's marginal utility (MU)
received in the consumption of each good. As a utility-maximizing consumer,
which combination of coffee and scones should Dorothy consume each day?
Cups of
Coffee
MU of Coffee
# of Scones
MU of scones
1
10
1
30
2
8
2
24
3
6
3
20
4
4
4
16
5
2
5
14
6
1
6
8
(A) 2 coffee and 2 scones
(B) 5 coffee and 6 scones
(C) 3 coffee and 2 scones
(D) 4 coffee and 4 scones
(E) 4 coffee and 16 scones
Utility and the Demand Curve (3/16)
1.Substitution effect
a. Price of notebooks falls = MU/P increases 
maximize utility by buying more notebooks,
fewer CDs
b. Price of product increases and quantity
demanded falls = law of demand (downward
sloping curve)
c. Good absorbs small share of customer’s
overall spending = substitution effect is
supreme
2. Income effect
a. Food and housing = large percentage of
spending for typical consumers
b. Ex: price of rent increases. Family feels
poorer  will demand smaller apt (less
housing) and fewer other goods
c. Exception: inferior goods
i. Ex: Rice in central China (large % of
income).
Price of rice falls  leads household to
feel “richer”. Will NOT buy more rice when
price
decreases, but will buy more relatively
expensive foods instead :O “Giffen good”
Or…price decreases, quantity demanded