Chapter 5
HAPPINESS, UTILITY AND
CONSUMER CHOICE
© 2013 Cengage Learning
Gottheil — Principles of Economics, 7e
1
Economic Principles
Happiness
Total utility and marginal utility
Law of diminishing marginal utility
Relationship between the law of demand
and the marginal-utility-to-price ratio
Consumer surplus
Producer surplus
Difficulties with interpersonal comparison
of utility
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Gottheil — Principles of Economics, 7e
2
Happiness and Utility
Economists measure happiness by creating the
concept of the util.
Util
• It is a hypothetical unit used to measure
how much utility a person obtains from
consuming a good.
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Gottheil — Principles of Economics, 7e
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Happiness and Utility
Utility measures the satisfaction or
enjoyment a person obtains from
consuming a good.
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Happiness and Utility
The implication of someone
experiencing increasing marginal
utility for pizza slices is:
• When his stomach is full to bursting from
eating so much pizza, the marginal utility from
eating yet another slice would be higher than
for any of the preceding slices.
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Happiness and Utility
The implication of someone
experiencing increasing marginal
utility for pizza slices is:
• It is not clear that someone could survive
having increasing marginal utility!
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Happiness and Utility
It possible for marginal utility to
become negative.
• For example, if you overeat and feel ill, then
the marginal utility for the last bit of food
you ate is negative.
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Happiness and Utility
A rational consumer will not knowingly
pay to buy a unit of a good that
generates negative marginal utility.
• Presumably something else could be bought
that generates positive marginal utility.
• Buying something that generates negative
marginal utility is not consistent with
utility maximization.
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EXHIBIT 1 TOTAL UTILITY AND MARGINAL UTILITY
DERIVED FROM CONSUMING T-BONE
STEAKS (UTILS)
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Exhibit 1: Total Utility and Marginal
Utility Derived From Consuming
T-Bone Steaks (utils)
If marginal utility is declining, but is
still positive, total utility is:
• Total utility increases as long as marginal
utility is positive.
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Exhibit 1: Total Utility and Marginal
Utility Derived From Consuming
T-Bone Steaks (utils)
If marginal utility is declining, but is
still positive, total utility is:
• In Exhibit 1, total utility reaches its maximum at
five t-bone steaks. Consuming more than five
steaks will reduce total utility.
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Gottheil — Principles of Economics, 7e
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EXHIBIT 2A TOTAL AND MARGINAL UTILITY
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EXHIBIT 2B TOTAL AND MARGINAL UTILITY
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Exhibit 2: Total and Marginal Utility
In Exhibit 2, the curves in Panel a
and b represent:
• The curve in Panel a is the total utility curve
for T-bone steaks.
• Panel a depicts the number of utils, or the
amount of utility, a person gains from
consuming a certain number of steaks.
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Exhibit 2: Total and Marginal Utility
In Exhibit 2, the curves in Panel a and
b represent:
• Total utility peaks at 81 utils, or 5 steaks.
Each steak consumed beyond 5 reduces total
utility.
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Exhibit 2: Total and Marginal Utility
In Exhibit 2, the curves in Panel a
and b represent:
• The curve in Panel b is the marginal utility
curve for T-bone steaks.
• The curve depicts the change in total utility a
person derives from consuming each
additional steak.
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Gottheil — Principles of Economics, 7e
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Exhibit 2: Total and Marginal Utility
In Exhibit 2, the curves in Panel a
and b represent:
• When marginal utility is zero, total utility is
maximized.
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Happiness and Utility
If water is necessary for life, then the
market price of water so much lower
than for diamonds because:
• Market price reflects marginal utility, not
total utility.
• Due to diminishing marginal utility and the
abundance of water, the marginal utility
of water is lower than for diamonds.
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Happiness and Utility
A hypothetical circumstance in which
the marginal utility of water might
exceed the marginal utility of a
diamond:
• If you are lost in the desert and are severely
dehydrated, then your marginal utility for a
gallon of water might exceed your
marginal utility for a diamond.
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French Cuisine and Marginal Utility
Many courses, each with small
portions of food (French cuisine), may
generate more utility than one course
with a large portion of food because:
• One large portion drives down marginal utility.
• Marginal utility is high for the whole meal.
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EXHIBIT 3 MARGINAL UTILITIES OF CLOTHES AND
AMUSEMENT GOODS (UTILS)
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Exhibit 3: Marginal Utilities of
Clothes and Amusement Goods
(Utils)
Based on the utility data in Exhibit 3, a
rational consumer will select the best
combination of clothes and
amusement goods:
• By sequentially picking units of clothing
and amusement goods that generate the
largest MU/P.
© 2013 Cengage Learning
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EXHIBIT 4 MARGINAL-UTILITY-TO-PRICE RATIOS OF
CLOTHES AND AMUSEMENT GOODS (MU/P)
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Exhibit 4: Marginal-Utility-to-Price
Ratios of Clothes and Amusement
Goods (MU/P)
If a unit of clothes and amusement
goods both cost $10, and if you have
$80 to spend, the rational consumer
will spend her money:
• MU/P is equal when three units of clothes
and five units of amusement goods are
purchased (MU/P = 1.4).
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Marginal-Utility-to-Price Ratio
Marginal-utility-to-price ratio
• The ratio is calculated by dividing the
marginal utility of a good by the price of the
good—MU/P.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle
• A person’s total utility is maximized when
the ratios of marginal utility to price for the
last unit of each of the goods consumed are
equal.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
• MU/P measures marginal utility per dollar
spent.
• Total utility will be maximized (within the
constraints of a limited budget) when
each individual purchase generates
the largest possible MU/P.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
• A rational and fully-informed consumer will
always shift a dollar from a good whose
MU/P is lower to one whose MU/P is higher,
if such a shift is possible.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
• The principle is based on consumer
behavior.
• Consumers will always arrange their
sequence of choices among goods starting
with the highest MU/P and running
down to exhaust an expenditure budget.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
• The consumer choice process is in
equilibrium when:
• There is no longer any incentive for the
consumer to rearrange her purchases.
• The MU/P is equal for the last unit of
each good or service consumed.
© 2013 Cengage Learning
Gottheil — Principles of Economics, 7e
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EXHIBIT 5 COMPARING MU/Ps AFTER A 20-PERCENTOFF SALE ON CLOTHES
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Exhibit 5: Comparing MU/Ps After a
20 Percent Off Sale on Clothes
The MU/P of clothes changes when
there is a 20 percent off sale on
clothes by:
• MU/P for each unit of clothing rises when price
is reduced by 20 percent.
• This will cause a rational consumer to
consume more clothes.
© 2013 Cengage Learning
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EXHIBIT 6 COMPARING MU/Ps AFTER A 50-PERCENTOFF SALE ON CLOTHES
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Gottheil — Principles of Economics, 7e
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Exhibit 6: Comparing MU/Ps After a
50 Percent Off Sale on Clothes
An additional reduction in the price of
clothing will change all of the MU/Ps for
clothing, and thus change a rational
consumer’s consumption of clothing.
• If the price of clothes falls again, from $8 to
$5, the quantity of clothing demanded
increases from four to six units.
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Gottheil — Principles of Economics, 7e
34
EXHIBIT 7 THE DEMAND CURVE FOR CLOTHES
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Gottheil — Principles of Economics, 7e
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Exhibit 7: The Demand Curve
for Clothes
When the price of clothing falls from
$10 to $8 to $5, which of the
following occurs:
• Quantity demanded remains the same.
• Quantity demanded falls from 6 to 4 to 3.
• Quantity demanded rises from 3 to 4 to 6.
© 2013 Cengage Learning
Gottheil — Principles of Economics, 7e
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Exhibit 7: The Demand Curve
for Clothes
When the price of clothing falls from
$10 to $8 to $5, which of the
following occurs:
• Quantity demanded remains the same.
• Quantity demanded falls from 6 to 4 to 3.
• Quantity demanded rises from 3 to 4 to 6.
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MU/P Equalization Principle
and the Law of Demand
Changes in the marginal-utility-toprice ratio are caused by:
• A change in the marginal utility of a good or
a change in the price of a good changes the
marginal-utility-to-price ratio, and therefore
changes quantity demanded.
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MU/P Equalization Principle
and the Law of Demand
The relationship between the MU/P
Principle and the Law of Demand:
If the price of a good falls:
• MU/P rises.
• The rational consumer will increase her
consumption of that good.
• Increase in quantity demanded
(movement along the demand curve).
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MU/P Equalization Principle
and the Law of Demand
The relationship between the MU/P
Principle and the Law of Demand:
If consumer preference for a good decreases:
• MU/P declines.
• The rational consumer will reduce consumption.
• The demand curve shifts to the left (since
consumer preference is a nonprice factor).
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MU/P Equalization Principle
and the Law of Demand
The relationship between the MU/P
Principle and the Law of Demand:
If consumer income increases:
• The consumer can pursue a lower MU/P.
• The consumer can afford to increase
consumption.
• An increase in the demand for normal
goods.
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MU/P Equalization Principle
and the Law of Demand
A downward-sloping demand curve
is consistent with the law of
diminishing marginal utility.
• Diminishing marginal utility means that
MU/P declines as quantity consumed
increases.
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Gottheil — Principles of Economics, 7e
42
MU/P Equalization Principle
and the Law of Demand
A downward-sloping demand curve
is consistent with the law of
diminishing marginal utility.
• A consumer’s willingness-to-pay falls as
quantity consumed increases.
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Are White Rats Rational Consumers?
There is evidence that lab rats
make consumer choices based
on MU/P.
• Economists Battalio and Kagel found that white
lab rats respond to price and income changes
in a manner consistent with economic theory.
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The MU/P Guide to Auction Bidding
MU/P can help guide auction
bidding:
• If a particular MU/P is guaranteed by buying
something outside of the auction, and if the
marginal utility from the auction good is
known, then you can figure out your
maximum auction price.
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Creating Consumer Surplus
Consumer surplus
• The difference between the maximum price a
person would be willing to pay for a good or
service, and the price the person actually pays.
• Most consumers receive some
consumer surplus from a transaction.
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Creating Consumer Surplus
When market price falls, consumer
surplus increases.
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Creating Consumer Surplus
If the price of a good is greater than
amount a consumer is willing to pay
for that good, the consumer surplus
will be negative if the consumer
buys the good.
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Creating Consumer Surplus
A rational consumer will not
purchase a good that generates
negative consumer surplus.
• A rational consumer will prefer zero
consumer surplus (no purchase) to negative
consumer surplus.
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EXHIBIT 8 Consumer and Producer Surplus in the
Lawn-Servicing Market
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Exhibit 8: Consumer and Producer
Surplus in the Lawn-Servicing Market
This demand curve reflects the willingness
—at each price—of consumers to buy lawn
service. The concept of consumer surplus
applies to lawn service:
• At a price of $20, all consumers with a
willingness-to-pay value of $20 or more will
get their grass cut.
• These consumers get consumer surplus.
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Exhibit 8: Consumer and Producer
Surplus in the Lawn-Servicing Market
Exhibit 8 depicts the demand and supply
curves for lawn service. The concept of
consumer surplus applies when:
• Some consumer may be willing to pay $45 for
a grass cut.
• This consumer will receive $(45 – 20) = $25
of consumer surplus.
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Exhibit 8: Consumer and Producer
Surplus in the Lawn-Servicing Market
Exhibit 8 depicts the demand and supply
curves for lawn service. The concept of
consumer surplus applies when:
A consumer who has a willingness-to-pay value
less than $20:
• Has a negative consumer surplus.
• Will not choose to purchase a ride
(a rational consumer).
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EXHIBIT 9 CHANGES IN CONSUMER AND PRODUCER
SURPLUS
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Exhibit 9: Changes in Consumer
and Producer Surplus
Kim’s consumer surplus from lawn
service changes with the willingness
to pay more as shown in both panels:
• What was $25 ($45 – 20) before
income increase, becomes …
• $30 ($55 – 25) after income increase
and stays at $30 when the price for
lawn service decreases in panel b.
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Exhibit 9: Changes in Consumer
and Producer Surplus
What happens to Henry’s producer
surplus when the supply of producers
increases?
• What was $15 ($25 – 10) per lawn in panel b
becomes …
• $5 ($15 – 10) after income increase.
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Interpersonal Comparisons
of Utility
An interpersonal comparison of
utility
• It is a comparison of the marginal utilities
that different people derive from a good or a
dollar.
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Interpersonal Comparisons
of Utility
Is it actually possible to compare the
satisfaction that different people derive
from a good or a dollar?
• It is not possible to make an exact comparison
of different peoples’ utility.
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Interpersonal Comparisons
of Utility
Is it actually possible to compare the
satisfaction that different people derive
from a good or a dollar?
• Policies such as those aimed at poverty
alleviation rely on society being able to make
approximate or reasonable comparisons
of utility across different people.
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