UTILITYUtility is satisfaction. We get utility from the consumption of goods

and services.We aim to maximise our total utility.Utility can be measured in units called “Utils”

MARGINAL UTILITYMarginal utility is

the extra satisfaction we get from consuming one more unit of a good.

The law of diminishing marginal utility states that as we consume more of the same good MU will begin to fall.

MU$

units

Example Sam loves cream donuts. The first donut he eats gives him 18

utils of satisfaction. The second donut gives him 12 utils of satisfaction. The third donut gives him 7 utils of satisfaction and the fourth donut gives him 1 util .

Copy and complete the table below then draw Sam's total and marginal utility graphs

Number of Donuts

Marginal Utility (extra satisfaction)

Total Utility from all Donuts consumed

1

2

3

4

Total and marginal Utility

Number of donuts

Copy and complete the following statements

• Marginal Utility __________ as more donuts are consumed

• Total Utility ____________ as more donuts are consumed but at a ____________ rate

• Total Utility will be the greatest when Marginal Utility equals ____

• Total Utility will fall if marginal utility is ___________

Falls

increases

Slower

0

Negative

TU

MU

$ $

QQ

q1 q1

When TU is maximumMU = 0

Putting a $ Value on Utility A person can put a dollar value on personal

satisfaction from consuming an item.

This value will be different for each person based on their personal preferences (i.e. Sam really likes cream donuts so may put on a higher dollar value on cream donuts than his workmate.

Example –

Quantity Marginal Utility Marginal Utility in dollars (each util is worth .50)

1 18

2 12

3 7

4 1

Sam values each util at 50centsComplete the final column in the table below

96

3.50

0.50

How many donuts will sam buy if the market price is each of the following ( Remember MU$ in the chart above represents sams personal satisfaction ($ value) from the last donut)

$8 =__________

$5 = __________

$2 = __________

1

2

3

OPTIMAL PURCHASE RULEA consumer will

consume to the point where P = MU.

A consumer will only buy extra units if their value of personal satisfaction from the extra unit is above or equal to the price they have to pay.

Using the Optimal Purchase Rule to find a persons Demand for a good or service

A persons demand for a good or service can be defined as The amount of a good or service that a person is

willing and able to buy at each price level

Marginal Utility will determine a person’s demand for a good or service.

An individual demand curve is the same as their marginal utility (dollars) curve.

Illustration Exercise Complete the

worksheet and stick into your notes

DEMANDUsing P=MU and a

consumers MU curve we can derive their demand.

Mu

$

unit

muQ

P

$

D

Demand and Marginal Utility The price that a person is willing to pay for a extra

unit is determined by their marginal utility from that unit

Earlier units of consumption have a higher marginal utility therefore consumers are willing to pay a higher price

Consumers will only by a extra unit of a good or service if the price falls…….......

This leads to the law of demand

Law of demand As price increases quantity demanded will decrease ( because consumers

can’t afford as much with their income) Vice versa, ceteris paribus

As price increases MU/P falls, so we buy less. If we are consuming at P=MU and price rises then P>MU so we buy less until P=MU

Workbooks page 109

Consumer Equilibrium Consumer equilibrium occurs when the

satisfaction from total spending by a consumer is maximised for a given level of income

• Optimal purchase rule – a consumer will consume up to the point where Price = $MU

• When buying many goods, a persons satisfaction is maximised when the last dollar spent on each good gives the same amount of satisfaction.

• Consumers are getting the most satisfaction from their total spending and have maximised their total utility

Equi – Marginal Rule

Example Text Book Page 25

PARADOX OF VALUE

It seems puzzling that water, which is essential for life, has a low value, whereas diamonds, which are not essential have a very high value.

Because we consume water in such large

quantities, the MU is low.

Diamonds however are consumed in small

amounts and so have a very high MU.

Exercises page 110-111

DESCRIBEThe trend for total utility as a person

consumes more and more of a product.The trend for marginal utility as a person

consumes more and more of a product.The trend for quantity demand as price

falls.The trend for the consumption of an

inferior good as income increases.The trend for the consumption of a normal

good as income increases.

EXPLAINWhy consumers increase their quantity

demand as price falls.

VocabularySatisfaction from

consumption of a good or service.

As more of a good is consumed, the extra satisfaction decreases.

The quantity a persons is able and willing to buy at a given price.

Vocabulary

A consumer will purchase up to the point where MU=P

A product used in place of another.

A product often used in conjunction with another.