To do today
On to consumer theory.
What do we choose to consume and why do we
choose it?
Going deeper behind the demand curve
(Note: Homework this Sunday)
On to consumer choice and demand theory
! Budget line
! Total vs. marginal utility
! Utility maximizing equilibrium
A budget tells us how much we have to spend
Point of the budget line
! The budget is the amount of money you have
to spend.
! How much you can buy depends on the
prices of the goods
! We restrict ourselves to two goods here so
we can graph it easily
Budget line for pizza and coke as the two goods
! Relative price: the price of one good divided by the price
of another good.
! Relative price also gives the slope of the budget line.
Example: Ppizza/Pcoke = $5/$1 and budget = $10
Changes in Prices with budget constant
!  If price of only one good changes
•  Consumption possibilities shrink if price rises and
expand if price falls
•  Price of pizza
falls to $2.50
What happens to the budget line?
! Rotates with a change in relative prices
! Because the slope changes as the relative
prices change
! A price decrease of the good on the y axis
causes an upward rotation around a fixed
point on the other axis.
Change in the Price of Good: All cases
!  Check yourself that you can rotate the
budget line appropriately if
a. the price of the good on the y axis rises
b. the price of the good on the x axis rises or
falls.
Next step: What do we buy with our budget and
why?
! 
And we measure utility
at the margin
Because we like it: we
get satisfaction or
utility
Marginal utility (MU)
The change in total utility that results from a one-unit
increase in the quantity of a good consumed.
Same as the usual definition of the term marginal.
What pattern does this follow as we increase
consumption?
Total utility: the sum of all marginal utilities
! Total Utility (TU)
Total benefit that a person gets from the consumption of
a good or service.
What happens to TU as the quantity of a good we
consume increases?
Calculating MU
The marginal utility of
the third bottle of water
is 36 units minus 27
units, which equals 9
units.
Diminishing marginal utility
General tendency for
MU to decrease as
the quantity of a good
consumed increases
TU and MU graphically
Graphs come from the data
below. Connect points A – D.
For TU, constantly increasing
but at a decreasing rate.
This means that MU is always
decreasing.
TU and MU graphically
Part (b) show marginal utility
from bottled water diminishes by
placing the bars shown in part
(a) side by side as a series of
declining steps.
The downward sloping blue line
is marginal utility curve.
Where are we and what is next?
!  Know the constraint – the budget
!  Know the total and marginal utility
!  Need a decision rule - maximize total utility
! How? Use MU and price information to do
this
Marginal utility per dollar spent
Marginal utility per dollar (MU/$)
the marginal utility from a good relative to the price paid
for the good.
Must take into account the price paid for the additional
utility.
Utility maximizing rule
Assumption: spend entire available budget.
Rule: Make the MU per dollar spent equal for all goods.
Why? If MU/$ for pizza > MU/$ for burgers, how can
you do better in terms of utility?
Buy more _______ and less __________ .
Getting back to the demand curve from MU
Figure shows demand
curve for bottled water
when budget is $4 a day
and gum is 50¢ a pack.
When water is $1 a bottle,
consumer buys __bottles
and is at point ___.
When water falls to 50¢ a
bottle, consumer buys ___
bottles and moves to point
__.
The demand curve comes from MU
What we did to get the demand curve
Find one point on a demand curve, say for water.
If budget is $4 a day, water is $1 a bottle and gum is 50¢
a pack, buy 2 bottles of water.
To find another point on the demand curve for water,
change the price of water to 50¢ a bottle.
Response to a price decrease
A fall in the price of water increases the MU/$ from water,
so buy more water.
This gives us the downward sloping demand curve.
What we need to know to draw the demand curve
When we first saw it, only needed the demand schedule –
your connections between price and quantity demanded
Now we need to know your MU and the price of goods.
What is your MU? Do you know it? What if you don’t?
EYE on SONG DOWNLOADS
How Much Would You Pay for a Song?
The music that we buy isn’t just one good—it is several
different goods.
We’ll distinguish singles from albums and focus on the
demand for singles.
In 2001, we bought 106 million singles and paid $4.95 on
the average for each one.
In 2007, we downloaded 802 million singles files and paid
99¢ for each one.
EYE on SONG DOWNLOADS
How Much Would You Pay for a Song?
Figure 2 shows the
demand curve for singles.
In 2001,106 million singles
were bought at an average
price of $4.95.
In 2007, 802 million singles
downloaded at 99¢ each.
The green area shows the
increase in consumer
surplus, which is $1.8
billion or an average of
$2.24 per single.