MARGINAL UTILITYIn relation to consumers!!!!!!

MARGINAL UTILITY

•Marginal = Extra

•Utility = Satisfaction

DIMINISHING MARGINAL UTILITY

•Lets test:• If a consumer consumes 1 extra unit (marginal) of a good or service in succession what happens to their utility (satisfaction) after the consumption of that good.

Yum 10 out of 10

Ok 8 out of 10

Ghosty 6 out of 10

Yum 10 out of 10

DEFINING MARGINAL UTILITY

As additional units of a G or S are consumed (consecutively) Total Utility increases at a decreasing rate.

OrAs additional units of a G or S are consumed (consecutively) Marginal Utility decreases.

LAW OF MARGINAL UTILITY

CRITERIA

• LI: Understand and apply the Law of Diminishing Marginal Utility

REVISIT

Yum 10 out of 10

Ok 8 out of 10

Ghosty 6 out of 10

Yum 10 out of 10

LAW OF MARGINAL UTILITY

As additional units of a G or S are consumed (consecutively) Total Utility increases at a decreasing rate.

OrAs additional units of a G or S are consumed (consecutively) Marginal Utility decreases.

THE OPTIMUM PURCHASE RULE P = MU

• Consumers will/should continue to consume up to where Price is equal to Marginal Utility (P = MU) as they will maximise their total utility.

• P = MU• P falls to P¹• P¹ ≠ MU (P¹ < MU)• Incentive to consume more• MU falls• P¹ = MU• Therefore a demand curve is drawn downward sloping to the right (i.e. as price falls, quantity demanded will increase)

THE OPTIMUM PURCHASE RULE P = MU

THE OPTIMUM PURCHASE RULE P = MU• P = MU

• P rises to P¹• P¹ ≠ MU (P¹ > MU)• Incentive to consume less• MU rises • P¹ = MU• Therefore a demand curve is drawn downward sloping to the right (i.e. as price rises, quantity demanded will fall)

A rational consumer will consume successive units of a good until they reach the point where P = MU. At this point the price that they are paying for the additional unit matches the marginal utility that they are receiving.

If P < MU then the consumer has an incentive to consume more because they are ‘getting a bargain’ (i.e. receiving more marginal utility than they are paying for)

If P > MU then the consumer has an incentive to consume less because they are ‘getting ripped off’ ( i.e. receiving less marginal utility than they are paying for)

THE OPTIMUM PURCHASE RULE P = MU

TABLE 1 Angela Agassi’s Utility Schedule for

Tennis BallsQuantity

Consumed (packs of

three)

Total utility ($)

Marginal utility ($)

1 60 2 40 3 120 4 5

Price ($) Quantity (3-packs)

70

40

20

Demand schedule for Ang Agassi

1. Fill in the missing gaps for Table 1

2. Complete the demand schedule for Ang Agassi

3. Graph Ang Agassi’s Demand Curve.

4. Explain why the demand curve slopes downward.

ANSWERS

TABLE 1 Angela Agassi’s Utility Schedule for

Tennis BallsQuantity

Consumed (packs of

three)

Total utility ($)

Marginal utility ($)

1 60 60

2 100 40 3 120 20

4 125 5

Price ($) Quantity (3-packs)

70 0

40 2

20 3

Demand schedule for Ang Agassi

4.

If Angela is a rational consumer she will purchase packs of tennis balls, until she reaches the point where P=MU (optimal purchase rule).

When the price of tennis balls falls, P<MU.

Because P<MU, there is an incentive for Angela to increase her consumption of tennis balls. As she consumes additional units, MU will fall.

Therefore a demand curve is drawn downward sloping to the right (i.e. as price falls, quantity demanded will increase)

CRITERIA

• LI: Understand and apply the Law of Diminishing Marginal Utility.

• Use the Law of Diminishing Marginal Utility to describe the demand curve

• Use Equal marginal rule to calculate the optimum amount of a good or service a consumer should consume to maximise his/her utility

QUIZ• (a) Define marginal utility.

Quantity Purchase

d

Total Utility

Marginal Utility(cents)

0 0

1 750

2 600

3 1 770

4 300

(d) Use the law of diminishing marginal utility to explain why Sam’s demand curve for DVDs will slope downward to the right.

Price

($)

Quantity

(DVD’S)

10

8

6

4

ANSWERS

Quantity Purchase

d

Total Utility

Marginal Utility(cents)

0 0 0

1 750 750

2 1 350 600

3 1 770 420

4 2 070 300

Price

($)

Quantity

(DVD’S)

10 0

8 0

6 2

4 3

The law of diminishing marginal utility states that as more of a good or service is consumed successively marginal utility falls.

A rational consumer will only increase consumption if P=MU.

As consumption increases from 1 to 2 goods MU falls from 750 to 600. The consumer will only purchase additional units if the price is lowered to where P=MU.

Therefore a demand curve is drawn downward sloping to the right

As additional units of a G or S are consumed (consecutively) Total Utility increases at a decreasing rate.

OrAs additional units of a G or S are consumed (consecutively) Marginal Utility decreases.

THE LAW OF EQUAL MARGINAL UTILITY AND CONSUMER EQUILIBRIUM

How can a consumer maximise his Utility on the next dollar spent.

What combination of goods/service is going to give the highest amount of utility.

INFORMATION WE HAVE:

Budget (fixed amount of money)

MU of both goods

Price of both goods

EXAMPLE

Quantity

MUx MUa/Pa MUy MUb/Pb

1 55 20

2 35 16

3 15 14

4 3 6

Price of burgers ($5) Price of chips ($2)

𝑀𝑈𝑎𝑃𝑎

=𝑀𝑈𝑏𝑃𝑏

FormulaEqui marginal

ruleIf Jimbo had $11 to spend, what combination of chips and burgers he should buy to maximise his utility.

Quantity

MUx MUa/Pa MUy MUb/Pb

1 55 11 20 10

2 35 7 16 8

3 15 3 14 7

4 3 0.6 6 3

Price of burgers ($5) Price of chips ($2)

QUICK QUIZ

• Jack and Jill both earn $10 pocket money. They spend all $10 on chips and lollies. Jill purchases six packets of chips and two packets of lollies.

• Use table 1 to determine the quantity of chips and lollies Jack should purchase to maximise his total utility.

• A packet of chips costs $1 and a packet of lollies costs $2.

Quantity of

chips

(packet)

Marginal

utility (utils)

MUa/MUb

chips

Quantity of

lollies

(packet)

Marginal

utility (utils)

MUa/MUb

lollies

1 400 1 400

2 350 2 300

3 250 3 200

4 100 4 100

5 50 5 50

ANSWER

Quantity of

chips

(packet)

Marginal

utility (utils)

MUa/Pa

chips

Quantity of

lollies

(packet)

Marginal

utility (utils)

MUa/Pa

lollies

1 400 400 1 400 200

2 350 350 2 300 150

3 250 250 3 200 100

4 100 100 4 100 50

5 50 50 5 50 25

4 packets of chips

3 packets of lollies