The following Work It Out feature explains how marginal utility can effect decision making. Gaining 31 utils and losing 18 utils is a net gain of This is just another way of saying that the total utility at Q 94 according to the last column in Table 3 is 13 more than the total utility at P Step 5.
Now repeat this step-by-step process of decision making with marginal utilities. Another way to look at this is by focusing on satisfaction per dollar. Because it gives him the highest marginal utility per dollar and it is affordable. This process of decision making suggests a rule to follow when maximizing utility. Since the price of T-shirts is twice as high as the price of movies, to maximize utility the last T-shirt chosen needs to provide exactly twice the marginal utility MU of the last movie.
At this choice, the marginal utility per dollar is the same for both goods. This argument can be written as a general rule: the utility-maximizing choice between consumption goods occurs where the marginal utility per dollar is the same for both goods. A sensible economizer will pay twice as much for something only if, in the marginal comparison, the item confers twice as much utility.
Notice that the formula for the table above is:. The following Work It Out feature provides step by step guidance for this concept of utility-maximizing choices. If we traded a dollar more of movies for a dollar more of T-shirts, the marginal utility gained from T-shirts would exactly offset the marginal utility lost from fewer movies. In other words, the net gain would be zero. The best we can do is trade two movies for another T-shirt, since in this example T-shirts cost twice what a movie does.
If we trade two movies for one T-shirt, we would end up at point R two T-shirts and four movies. Choice 4 in Table 4 shows that if we move to point S, we would lose 21 utils from one less T-shirt, but gain 23 utils from two more movies, so we would end up with more total utility at point S.
There is another, equivalent way to think about this. The general rule can also be expressed as the ratio of the prices of the two goods should be equal to the ratio of the marginal utilities.
When the price of good 1 is divided by the price of good 2, at the utility-maximizing point this will equal the marginal utility of good 1 divided by the marginal utility of good 2.
This rule, known as the consumer equilibrium , can be written in algebraic form:. Along the budget constraint, the total price of the two goods remains the same, so the ratio of the prices does not change.
However, the marginal utility of the two goods changes with the quantities consumed. At the optimal choice of one T-shirt and six movies, point S, the ratio of marginal utility to price for T-shirts matches the ratio of marginal utility to price for movies of This discussion of utility started off with an assumption that it is possible to place numerical values on utility, an assumption that may seem questionable.
However, while measuring utility with numbers is a convenient assumption to clarify the explanation, the key assumption is not that utility can be measured by an outside party, but only that individuals can decide which of two alternatives they prefer.
To understand this point, think back to the step-by-step process of finding the choice with highest total utility by comparing the marginal utility that is gained and lost from different choices along the budget constraint.
In this way, the step-by-step process of choosing the highest level of utility resembles rather closely how many people make consumption decisions.
We think about what will make us the happiest; we think about what things cost; we think about buying a little more of one item and giving up a little of something else; we choose what provides us with the greatest level of satisfaction. The vocabulary of comparing the points along a budget constraint and total and marginal utility is just a set of tools for discussing this everyday process in a clear and specific manner. It is welcome news that specific utility numbers are not central to the argument, since a good utilimometer is hard to find.
Do not worry—while we cannot measure utils, by the end of the next module, we will have transformed our analysis into something we can measure—demand. Economic analysis of household behavior is based on the assumption that people seek the highest level of utility or satisfaction. Individuals are the only judge of their own utility. In general, greater consumption of a good brings higher total utility. However, the additional utility received from each unit of greater consumption tends to decline in a pattern of diminishing marginal utility.
The utility-maximizing choice on a consumption budget constraint can be found in several ways. You can add up total utility of each choice on the budget line and choose the highest total. You can choose a starting point at random and compare the marginal utility gains and losses of moving to neighboring points—and thus eventually seek out the preferred choice. Alternatively, you can compare the ratio of the marginal utility to price of good 1 with the marginal utility to price of good 2 and apply the rule that at the optimal choice, the two ratios should be equal:.
Praxilla, who lived in ancient Greece, derives utility from reading poems and from eating cucumbers. Higher education is generally viewed as a good investment, if one can afford it, regardless of the state of the economy. Microeconomics seeks to understand the behavior of individual economic agents such as individuals and businesses. Generally, consumers are trying to get the most for their limited budget.
In economic terms they are trying to maximize total utility, or satisfaction, given their budget constraint. Everyone has their own personal tastes and preferences. An economic explanation for why people make different choices begins with accepting the proverbial wisdom that tastes are a matter of personal preference. However, economists also believe that the choices people make are influenced by their incomes, by the prices of goods and services they consume, and by factors like where they live.
This section introduces the economic theory of how consumers make choices about what goods and services to buy with their limited income. If you look at Facebook for five fewer minutes a day, will you really be more productive? Is it worth it to clock into work ten minutes early, or would it be best to spend that time with your significant other?
Is it worth it to spend five dollars on a dessert when you already feel a little bit full? In this section, you will examine choices made at the margin, or the decisions you make to do a little more or a little less of something. Information on the consumption choices of Americans is available from the Consumer Expenditure Survey carried out by the U. Bureau of Labor Statistics. Figure 1 shows spending patterns for the average U.
The first row shows income and, after taxes and personal savings are subtracted, it shows that, in , the average U. The table then breaks down consumption into various categories. The average U. These patterns will vary for specific households by differing levels of family income, by geography, and by preferences. Because the first available units of any economic good will be put to the most highly valued uses, and subsequent units go to lower-valued uses, this ordinal theory of utility is useful for explaining the law of diminishing marginal utility and fundamental economic laws of supply and demand.
To Bernoulli and other economists, utility is modeled as a quantifiable or cardinal property of the economic goods that a person consumes. The concept of a measurable util makes it possible to treat economic theory and relationships using mathematical symbols and calculations. If, for example, an individual judges that a piece of pizza will yield 10 utils and that a bowl of pasta will yield 12 utils, that individual will know that eating the pasta will be more satisfying.
For the producers of pizza and pasta, knowing that the average bowl of pasta will yield two additional utils will help them price pasta slightly higher than pizza. Additionally, utils can decrease as the number of products or services consumed increases.
The first slice of pizza may yield 10 utils, but as more pizza is consumed, the utils may decrease as people become full. This process will help consumers understand how to maximize their utility by allocating their money between multiple types of goods and services as well as help companies understand how to structure tiered pricing.
Economic utility can be estimated by observing a consumer's choice between similar products. However, measuring utility becomes challenging as more variables or differences are present between the choices. If utility in economics is cardinal and measurable, the total utility TU is defined as the sum of the satisfaction that a person can receive from the consumption of all units of a specific product or service. Using the example above, if a person can only consume three slices of pizza and the first slice of pizza consumed yields ten utils, the second slice of pizza consumed yields eight utils, and the third slice yields two utils, the total utility of pizza would be twenty utils.
Marginal utility MU is defined as the additional cardinal utility gained from the consumption of one additional unit of a good or service or the additional ordinal use that a person has for an additional unit. Using the same example, if the economic utility of the first slice of pizza is ten utils and the utility of the second slice is eight utils, the MU of eating the second slice is eight utils.
If the utility of a third slice is two utils, the MU of eating that third slice is two utils. In ordinal utility terms, a person might eat the first slice of pizza, share the second slice with their roommate, save the third slice for breakfast, and use the fourth slice as a doorstop.
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