ECON107
Principles of
Microeconomics
Week 9
NOVEMBER 2013
Chapter-8
1
9w/11/2013
Dr. Mazharul Islam
8
8w/11/2013
Utility and Demand
Dr. Mazharul Islam
3
Lesson Objectives
 Examine
how individual consumers
allocate their incomes among the
various goods and services that
available to them to get maximum
utility?
 Given a particular budget, how does a
consumer decide what goods and
services to buy?
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Dr. Mazharul Islam
4
Issues of Discussion
 Utility
Defined
 Total Utility
 Marginal Utility
 Subjective Nature
 Difficult to Quantify
 Law of Diminishing Marginal Utility
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Dr. Mazharul Islam
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Definitions
 Utility:
It reflects the benefit or
satisfaction or pleasure of consumers
that gets from goods and services.
 Total utility is the total satisfaction a
person derives from consumption.
Generally, more consumption gives
more utility.
 Marginal utility is the change in total
utility resulting from one-unit change
in consumption of a good. As the
quantity consumed of a good
increases, the marginal utility from
consuming it decreases.
9w/11/2013
Dr. Mazharul Islam
TOTAL AND
MARGINAL UTILITY
6
TU
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
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10
8
6
4
2
0
-2
20
10
0
Marginal Utility (utils)
Number Total Marginal
Of glass Utility, Utility,
Utils
Utils
Total Utility (utils)
30
10
8
6
4
2
0
-2
1
2
3
4
5
6
7
Units consumed per beef burger (BB)
1
2
3
4
5
6
7
MU
Units consumed per BB
Dr. Mazharul Islam
TOTAL AND
MARGINAL UTILITY
7
TU
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
9w/11/2013
10
8
6
4
2
0
-2
20
10
Observe
Diminishing
Marginal
Utility
0
Marginal Utility (utils)
Number Total Marginal
Of glass Utility, Utility,
Utils
Utils
Total Utility (utils)
30
10
8
6
4
2
0
-2
1
2
3
4
5
6
7
Units consumed per beef burger (BB)
1
2
3
4
5
6
7
MU
Units consumed per BB
Dr. Mazharul Islam
8
Maximizing Utility

The key assumption of marginal utility
theory is that the household chooses the
consumption possibility that maximizes
total utility.

The Utility-Maximizing Choice
We can find the utility-maximizing choice
by looking at the total utility that
arises
from each affordable combination.

The utility-maximizing combination is called
a consumer equilibrium.
9w/11/2013
Dr. Mazharul Islam
9
Maximizing Utility
Utility-Maximizing Condition
 Consumer equilibrium is achieved when
the budget is completely spent and
Equalize the marginal utility per dollar for
all goods. The marginal utility per dollar is
the marginal utility from a good divided by
its price.
MUp
MU
v

Pv
Pp
 Where
MUp is the marginal utility of pizza,
pp is the price of pizza, MUv is the marginal
utility of videos, and pv the price of videos
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Dr. Mazharul Islam
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Maximizing Utility

If MUp/Pp > MUv/Pv,
then spend more on pizza and less on
videos. MUp will decrease and MUv will
increase.

If MUp/Pp < MUv/Pv,
then spend more on videos and less on
pizza. MUp will increase and MUv will
decrease.
Only when, MUp/Pp= MUv/Pv, is it not possible
to reallocate the budget and increase total
utility.
9w/11/2013
Dr. Mazharul Islam
11
Utility Maximization
 To
see your income is allocated
between two goods so as to maximize
utility, suppose we start with some
combination of pizzas and videos
 If
we can increase utility by
reallocating our expenditures we will
do so, and we will continue to make
adjustments as long as utility can be
increased  when no further utilityincreasing moves are possible, we
have arrived at the equilibrium
combination
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Dr. Mazharul Islam
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Example
Suppose that we have the following
bits of information
 The
price of pizza per unit is $8
 The rental price of a movie video is $4
 After tax income equals $40 per week
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Dr. Mazharul Islam
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Consumed
Per Week
(1)
Total
Utility
of Pizza
(2)
Marginal
utility
of Pizza
(3)
per Dollar
Marginal utility
(price=$8)
(4)
Video
Total
Rentals Utility of
per Week Videos
(5)
(6)
Marginal
utility of
Videos
(7)
per Dollar
marginal Utility of
(price=$4)
(8)
0
0
-
-
0
0
-
-
1
56
56
7
1
40
40
10
2
88
32
4
2
68
28
7
3
112
24
3
3
88
20
5
4
130
18
2¼
4
100
12
3
5
142
12
1½
5
108
8
2
6
150
8
1
6
114
6
1½
To get the process going, suppose you start off spending your entire budget of $40
on pizza  5 pizzas per week at a total utility of 142.
If you give up one pizza, you free up enough money to rent 2 videos. Would total
utility increase from this reallocation? You give up 12 units of utility – the
marginal utility of the 5th unit of pizza, to get 68 units of utility from the first 2
videos  total utility increases from 142 to 198.
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Dr. Mazharul Islam
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Now it’s over for today. Do you
have any question?
5w/9/2013
Dr. Mazharul Islam