Consumer Behavior: Utility Maximization - Harper College

To obtain the greatest utility the consumer should allocate money income so that the last dollar spent on each good or service yields the same marginal utility. 6a-Consumer Decisions:UtilityMaximization  OUTLINE--LESSON 6a ConsumerBehavior- ConsumerDecisions:UtilityMaximization  I.Introduction A.Anexampleof diminishingmarginalutility Readthe followingfromanonlineskiingdiscussionforum andanswerthequestionWHY? From epicski.com BarkingBearsForum: Skiing in/pastMarch:whynot popular? So,herein Oregon,wecontinuetogethammeredbycold storms.LastweekitwassnowdowninPortland, anddry,deepsnowupintheCascades(16-20" newovernight):thestuffthathappensonce everycoupleofyearsinOregon.Today,thereis another7"ofnewsnowonthemountain,andsnow predictedon/offforthenexttwoweeks.Baseis at175"andisveryconsolidated(wehavehad plentyofrainwiththatsnow):thatis all-natural,non-manmadesnow. But,forsome reason,peoplejuststopskiing.WHY?Ijust don'tunderstand.Theskiingisgreat,thesnow issuperb!Whatelsecantheydothistimeof year?Sitinsideandwatchitrain?WegetBIG dumps,andnobodyisonthehill.Likewisein lateApril/earlyMay,whichhasprimospring conditions(andtheoccasionalgoodstorm, followedbyabluebirdday,whichdoesn'tget anybetter)andagain,nobodyisonthe hill! B.ConsumerandProducer Decisions 1.Consumer Decisions Howmuchto buy? Goal:maximize utility Lesson 6a 2.Producer Decisions Howmuchto produce? Goal:maximize profits Lessons8/9,10,and 11 C.Review 1.Definition-- Economics 2.Definition--Benefit-CostAnalysis 3.Definition--Utility Definition:the want-satisfyingpowerofagoodorsurvice;thesatisfaction orpleasureongetsfromconsumingagoodor service "utility"doesnotmean "usefulness" Utilityissubjective- variesfrompersontoperson Utilitycannotbemeasured /itcanbecompared wewillassumethat utilitycanbemeasuredinunitscalled "utils" D.LawofDiminishingMarginal Utility AnexplanationoftheLaw ofDemand Asaconsumerincreasesthe consumptionofagoodorservicethemarginalutilityobtained fromeachadditionalunitofthegoodorservice decreases. II.Theoryof ConsumerBehavior A.TotalUtilityand MarginalUtility 1.utility Thewant-satisfying powerofagoodorservice;thesatisfactionorpleasurea consumerobtainsfromtheconsumptionofagoodor service 2.totalutility/ graph Thetotalamountof satisfactionderivedfromtheconsumptionofasingle productoracombinationofproducts. 3.marginal utility a. definition Theextrautilitya consumerobtainsfromtheconsumptionofoneadditional unitofagoodorservice; b. calculation equaltothechange intotalutilitydividedbythechangeinthequantity consumed. MU= TU/ Qconsumed c.graph 1.yellow page 2. textbook d.lawofdiminishing marginalutility Asaconsumer increasestheconsumptionofagoodorservicethe marginalutilityobtainedfromeachadditionalunitof thegoodorservicedecreases. 3.MU,demand,and elasticity a.DiminishingMU explainsthelawofdemand b.MUand elasticity (1)ifMU declinesquicklyasmoreisconsumed,thendemandisless elastic Explanation: iftheprice declines,onlyALITTLEmorewillbepurchasedsince LITTLEextrautilityisrecieved Demandisless elastic (2)ifMUdeclines slowlyasmoreisconsumed,thendemandismore elastic Explanation: iftheprice declines,ALOTmorewillbeconsumedsincetheMUof theseadditionalunitsremainsHIGH Demandismore priceelastic   B.Consumer ChoiceandtheBudgetConstraint:UtilityMaximizingRule (benefit-costanalysis) 1. assumptions a.rational behavior b.preferencesareknownandmeasurable c.budgetconstraint d.prices 2.utilitymaximizing rule Toobtainthegreatest utilitytheconsumershouldallocatemoneyincomesothat thelastdollarspentoneachgoodorserviceyieldsthe samemarginalutility. MUx/Px=MUy/Py =MUz/Pz(see below) 3.Butthisisreallyjust Benefit-CostAnalysis(see Ch1): a. Benefit-Cost-Analysis: select allwhere:MB>MC up towhere:MB=MC butneverwhere:MB