ECONOMICS 5e
Michael Parkin
Utility and Demand
Learning Objectives
• Explain the household’s budget constraint
• Define total utility and marginal utility
• Explain the marginal utility theory of
consumer choice
• Use marginal utility theory to predict the
effects of changing prices and incomes
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Learning Objectives (cont.)
• Explain the connection between individual
demand and market demand
• Explain the paradox of value
Copyright © 1998 Addison Wesley Longman, Inc.
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Learning Objectives
• Explain the household’s budget constraint
• Define total utility and marginal utility
• Explain the marginal utility theory of
consumer choice
• Use marginal utility theory to predict the
effects of changing prices and incomes
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Household Consumption Choices
Two concepts determining consumption
choices
• Budget constraint
• Preferences
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Budget Constraint
• Consumption choices are constrained by the
household’s income and prices.
• These limits are described by its budget
line.
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Consumption Possibilities
Possibility
Movies ($6)
Soda ($3)
Expenditure
Quantity (dollars)
Expenditure
Six-packs
(dollars)
a
0
0
10
30
b
1
6
8
24
c
2
12
6
18
d
3
18
4
12
e
f
4
5
24
30
2
0
6
0
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Consumption Possibilities
Soda (six-packs per month)
5
a
b
4
c
3
Unaffordable
d
2
1
Affordable
e
f
0
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1
2
3
4
5
Movies (per month)
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Learning Objectives
• Explain the household’s budget constraint
• Define total utility and marginal utility
• Explain the marginal utility theory of
consumer choice
• Use marginal utility theory to predict the
effects of changing prices and incomes
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Preferences
Consumption decisions depend upon a
person’s likes and dislikes, or
preferences.
Utility is the benefit or satisfaction that
a person gets from the consumption of
a good or service.
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Preferences
Total utility is the total benefit that a person
gets from the consumption of goods and
services.
Marginal Utility is the change in total utility
that results from a one-unit increase in the
quantity of a good consumed.
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Preferences
Diminishing marginal utility occurs
when the marginal utility decreases as
the quantity of a good consumed
increases.
Why does marginal utility decrease?
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Maria’s Total Utility
from Movies and Soda
Movies
Soda
Quantity
Six-packs
per month Total Utility Total utility
0
1
2
3
4
5
6
7
0
50
88
121
150
175
196
214
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0
75
117
153
181
206
225
243
Movies
Soda
Quantity
Six-packs
per month Total Utility Total utility
8
9
10
11
12
13
14
229
241
250
256
259
261
262
260
276
291
305
318
330
341
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Total Utility and Marginal Utility
Movies
Quantity
Total utility
0
0
1
50
2
88
3
121
4
150
5
175
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Marginal utility
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Total Utility and Marginal Utility
Movies
Quantity
Total utility
0
0
50
1
50
38
2
88
33
3
121
29
4
150
25
5
175
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Marginal utility
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Total
utility
200
150
100
Increasing
total utility...
50
0
Units of utility
Units of utility
Total Utility and Marginal Utility
…and diminishing
marginal utility
50
1
2
3
4
5
Quantity (movies per month)
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0
Marginal
utility
1
2
3
4
5
Quantity (movies per month)
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Learning Objectives
• Explain the household’s budget constraint
• Define total utility and marginal utility
• Explain the marginal utility theory of
consumer choice
• Use marginal utility theory to predict the
effects of changing prices and incomes
Copyright © 1998 Addison Wesley Longman, Inc.
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Maximizing Utility
Marginal Utility Theory
Assumes people choose the consumption possibility
that maximizes their total utility.
People’s wants exceed the resources available to
satisfy those wants.
Choices
In making choices, people try to maximize total
utility.
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Maria's Affordable Combinations
Movies
Soda
Quantity
per month Total utility
Total utility
from movies
and soda
Total utility
Six-packs
per month
a
0
0
291
291
10
b
1
50
310
260
8
c
2
88
313
225
6
d
3
121
302
181
4
e
4
150
267
117
2
f
5
175
175
0
0
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Maximizing Utility
Consumer equilibrium
A situation in which a consumer has
allocated all his or her available income in a
way that, given the prices of goods and
services, maximizes his or her total utility.
Occurs at the combination that equates the
marginal utility per dollar spent for all
goods.
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Maximizing Utility
Consumer equilibrium
Marginal utility
from movies
=
Price of a movie
Marginal utility
from soda
Price of soda
OR
MUm
Pm
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=
MUs
Ps
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Equalizing Marginal Utilities
per Dollar Spent
Movies ($6 each)
Quantity
a
b
c
d
e
f
0
1
2
3
4
5
Marginal
utility
Marginal per dollar
utility
spent
0
50
38
33
29
25
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8.33
6.33
5.50
4.83
4.17
Soda ($3 per six-pack)
Marginal
Quantity utility
10
8
6
4
2
15
17
19
28
42
Marginal
utility
per dollar
spent
5.00
5.67
6.33
9.33
14.00
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Marginal utility per dollar spent
(units of utility per dollar)
Equalizing Marginal Utilities
per Dollar Spent
MUs
Ps
16.00
12.00
Utility gain
from more
soda and
fewer movies
Maximum
total utility
8..33
6..33
5..67
4.00
Movies
Soda
Possibility
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0
10
a
1
8
b
Utility gain
from more
movies and
less soda
2
6
c
MUm
Pm
3
4
d
4
2
e
5
0
f
TM 8-‹#›
Learning Objectives
• Explain the household’s budget constraint
• Define total utility and marginal utility
• Explain the marginal utility theory of
consumer choice
• Use marginal utility theory to predict the
effects of changing prices and incomes
Copyright © 1998 Addison Wesley Longman, Inc.
TM 8-‹#›
Predictions of Marginal
Utility Theory
If the price of a good changes, the
marginal utility per dollar spent will
change.
As a result, the quantity demanded for
the good will change.
Also, the demand for the good may
change if people substitute goods for one
another.
Copyright © 1998 Addison Wesley Longman, Inc.
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How a Change in Price of
Movies Affects Maria’s Choices
What happens to the Maria’s consumption
of movies and soda if the price of movies
fall to $3?
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How a Change in Price of Movies
Affects Maria’s Choices
Movies ($3 each)
Quantity
0
1
2
3
4
5
6
7
8
9
10
Soda ($3 per six pack)
Marginal
utility
Per dollar
spent
Six-packs
16.67
12.67
11.00
9.67
8.33
7.00
6.00
5.00
4.00
3.00
10
9
8
7
6
5
4
3
2
1
0
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Marginal
utility
Per dollar
spent
5.00
5.33
5.67
6.00
6.33
8.33
9.33
12.00
14.00
25.00
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Movies
6
Maria’s demand
for movies
3
0
2
5
Price (dollars per six-pack)
Price (dollars per movie)
A Fall in the Price of Movies
Quantity (movies per month)
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Soda
6
Maria’s demand
for soda when
movies cost $6
Maria’s demand
for soda when
movies cost $3
3
0
5
6
Quantity (six-packs per month)
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How a Change in Price of
Movies Affects Maria’s Choices
What happens to the Maria’s consumption
of movies and soda if the price of sodas rise
to $6?
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How a Change in Price of Soda
Affects Maria’s Choices
Movies ($3 each)
Quantity
0
2
4
6
8
10
Marginal
utility
Per dollar
spent
12.67
9.67
7.00
5.00
3.00
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Soda ($3 per six pack)
Six-packs
Marginal
utility
Per dollar
spent
5
4
3
2
1
4.17
4.67
6.00
7.00
12.50
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Soda
6
Maria’s demand
for soda
3
0
2
5
Price (dollars per movie)
Price (dollars per six-pack)
A Rise in the Price of Soda
Quantity (six-packs per month)
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Movies
6
Maria’s demand
for movies when
soda costs $6
Maria’s demand for
movies when soda
costs $3
3
0
5
6
Quantity (movies per month)
TM 8-‹#›
Predictions of Marginal
Utility Theory
Marginal utility theory predicts two results:
When the price of a good rises, the quantity
demanded for that good decreases.
If the price of one good rises, the demand
for another good that can serve as a
substitute increases.
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A Rise in Income
What happens to Maria’s consumption of
movies and soda if her income rises from
$30 a month to $42?
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Maria’s Choices with an
Income of $42 a Month
Movies ($3 per movie)
Marginal
utility
per dollar
Quantity
spent
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
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16.67
12.67
11.00
9.67
8.33
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.67
0.33
Soda ($3 per six pack)
Marginal
utility
per dollar
Six-packs
spent
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
3.67
4.00
4.33
4.67
5.00
5.33
5.67
6.00
6.33
8.33
9.33
12.00
14.00
25.00
TM 8-‹#›
Learning Objectives (cont.)
• Explain the connection between individual
demand and market demand
• Explain the paradox of value
Copyright © 1998 Addison Wesley Longman, Inc.
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Individual Demand and
Market Demand
Market demand
The relationship between the total quantity
demanded of a good and its price.
Individual demand
The
relationship
between
quantity
demanded of a good by a single individual
and its price.
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Individual and Market
Demand Curves
Price
Quantity of movies demanded
(dollars per movie)
Maria
7
1
0
6
2
0
5
3
0
4
4
1
3
5
2
2
6
3
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Ivan
Market
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Individual and Market
Demand Curves
Price
Quantity of movies demanded
(dollars per movie)
Maria
7
1
0
1
6
2
0
2
5
3
0
3
4
4
1
5
3
5
2
7
2
6
3
9
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Ivan
Market
TM 8-‹#›
8
Maria’s demand
6
4
3
2
Price (dollars per movie)
Price (dollars per movie)
Individual and Market
Demand Curves
8
6
4
3
2
5 movies
0
2
4
2 movies
5
6
8
Quantity (movies per month)
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Ivan’s demand
0
2
4
5
6
8
Quantity (movies per month)
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Price (dollars per movie)
Individual and Market
Demand Curves
8
Market Demand
6
4
3
2
5 + 2 = 7 movies
0
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2
4
6 7 8
10
Quantity (movies per month)
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Learning Objectives (cont.)
• Explain the connection between individual
demand and market demand
• Explain the paradox of value
Copyright © 1998 Addison Wesley Longman, Inc.
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Efficiency, Price, and Value
The Paradox of Value
Why does water, which is essential for life,
cost so little?
Why do diamonds, which are useless
compared to water, cost so much?
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Price of water
The Paradox of Value
Water
Consumer
surplus from
water
Pw
S
D
Qw
Quantity of water
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The Paradox of Value
Price of a diamond
S
Diamonds
Consumer
surplus from
diamonds
PD
D
QD
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Quantity of diamonds
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The Paradox of Value
Diamonds have a high price and a high
marginal utility, while water has a low
price and a low marginal utility.
The marginal utility per dollar spent is the
same for diamonds as for water.
Copyright © 1998 Addison Wesley Longman, Inc.
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