Sub: Microeconomic Dr/ Zeyad Albukhaiti

Lecture 10
CONSUMER CHOICE (cont’d)
(Utility and Consumer Equilibrium)
 The Solution to the Diamond–Water Paradox
Goods have both total utility and marginal utility. Water, for example, is extremely
useful: we cannot live without it. Thus, we would expect its total utility (its total usefulness)
to be high, but its marginal utility to be low because water is relatively plentiful. As the law
of diminishing marginal utility states, the utility of successive units of a good diminishes as
consumption of the good increases. In short, water is immensely useful, but there is so much
of it that individuals place relatively little value on another unit of it.
In contrast, diamonds are not as useful as water. Hence, we would expect the total utility
of diamonds to be lower than that of water, but their marginal utility to be high because there
are relatively few diamonds in the world. In other words, the consumption of diamonds (in
contrast to that of water) takes place at relatively high marginal utility. Diamonds, which are
rare, are used only for their few valuable uses. Water, which is plentiful, gets used for its
many valuable uses as well as for its not-so-valuable uses (e.g., spraying the car with the
hose for 2 more minutes even though you are 99 percent sure that the soap is fully rinsed
off). So, the total utility of water is high because water is extremely useful. The total utility
of diamonds is comparatively low because diamonds are not as useful as water.
The marginal utility of water is low because water is so plentiful that people consume it at
low marginal utility. The marginal utility of diamonds is high because diamonds are so
scarce that people consume them at high marginal utility.
Prices therefore reflect marginal utility, not total utility.
- questions (State and solve the diamond–water paradox.)
 Consumer Equilibrium and Demand
This section identifies the condition necessary for consumer equilibrium and then
discusses the relationship between equilibrium and the law of demand. The analysis is based
on the assumption that individuals seek to maximize utility.
 Sub: Microeconomic Dr/ Zeyad Albukhaiti
Lecture 10
 Equating Marginal Utilities per Dollar
Suppose there are only two goods in the world: apples and oranges. At present, a consumer
is spending his entire income consuming 10 apples and 10 oranges a week. For a particular
week, the marginal utility (MU ) and price (P ) of each are as follows:
MU oranges = 30 Utils
MU apples = 20 Utils
P oranges = $1
P apples = $1
So, the consumer’s marginal (last) dollar spent on apples returns 20 utils per dollar, and his
marginal (last) dollar spent on oranges returns 30 utils per dollar. The ratio MUO /PO (O =
oranges) is greater than the ratio MUA /PA (A = apples):
𝑴𝑼𝑶 𝑴𝑼𝑨
>
𝑷𝑶 𝑷𝑨
If the consumer recognizes this fact one week, he might redirect his purchases of apples
and oranges the next week: “If I buy an orange, I receive more utility [30 utils] than if I buy
an apple [20 utils]. It’s better to buy 1 more orange with $1 and 1 less apple. I gain 30 utils
from buying the orange, which is 10 utils more than if I buy the apple.”
As the consumer buys 1 more orange and 1 less apple, however, the marginal utility of
oranges falls (recall what the law of diminishing marginal utility says about consuming
additional units of a good), and the marginal utility of apples rises (the consumer is
consuming fewer apples). Because the consumer has bought 1 more orange and 1 less apple,
he now has 11 oranges and 9 apples. At this new combination of goods,
MU oranges = 25 Utils
MU apples = 25 Utils
P oranges = $1
P apples = $1
Now the ratio MUO /PO equals the ratio MUA /PA. The consumer is getting exactly the
same amount of utility (25 utils) per dollar from each of the two goods. There is no way for
the consumer to redirect his purchases (i.e., buy more of one good and less of another good)
 Sub: Microeconomic Dr/ Zeyad Albukhaiti
Lecture 10
and have more utility. Thus, the consumer is in equilibrium; that is, he derives the same
marginal utility per dollar for all goods.
Consumer Equilibrium "The equilibrium that occurs when the consumer has spent all of his
or her income and the marginal utilities per dollar spent on each good purchased are equal:
The condition for consumer equilibrium is:
𝑴𝑼𝑨 𝑴𝑼𝑩 𝑴𝑼𝒄 𝑴𝑼𝒛
1- = = = ……..=
𝑷𝑨 𝑷𝑩 𝑷𝒄 𝑷𝒛

2- The consumer spend entire his income.

where the letters A–Z represent all the goods a person buys.(We are assuming that the
consumer exhausts his or her income and that saving is treated as a good).

A person in consumer equilibrium has maximized total utility. By spending his or her
dollars on goods that give the greatest marginal utility and, in the process, bringing about the
consumer equilibrium condition, the consumer is adding as much to total utility as is
[Link] illustrate that, let us take the following example:

Example : Suppose that Utilities which consumer gained it from consumption of two goods
X , Y as the following table:

Good X Good Y
Marginal Utility Marginal Utility
Qx (MU) QY (MU)
1 40 1 50
2 35 2 40
3 30 3 30
4 25 4 20
5 20 5 15
6 15 6 10
7 10 7 5
8 5 8 0
If the prices of X,Y are 5$ , 10$ respectively, and the consumer's income about 45$
Required: Calculate the consumer equilibrium?
 Sub: Microeconomic Dr/ Zeyad Albukhaiti
Lecture 10
Solution:

Firstly, we should to calculate the Marginal Utility of the dollar spent on goods as the
following:

Good X Good Y
Marginal Utility Marginal Utility
Marginal Utility 𝑴𝑼𝒙 Marginal Utility 𝑴𝑼𝒚
Qx (MU) of Dollar QY (MU) of Dollar
𝑷𝒙 𝑷𝒚

1 40 8 1 50 5
2 35 7 2 40 4
3 30 6 3 30 3
4 25 5 4 20 2
5 20 4 5 15 1.5
6 15 3 6 10 1
7 10 2 7 5 0.5
8 5 1 8 0 0
From the above table we evident that the consumer equilibrium situation under its limited
income determined when he purchase 5 units of the X good and 2 units of Y good, and
therefore the both two condition of equilibrium had been achieved as following:

𝑴𝑼𝒙 𝑴𝑼𝒚
1- =
𝑷𝒙 𝑷𝒚

4 = 4

2- The consumer spend entire his income ( $45)

Example : Suppose that Total Utility which consumer gained it from consumption of two
goods X , Y as the next table:
Sub: Microeconomic Dr/ Zeyad Albukhaiti
Lecture 10
Good X Good Y
Marginal Marginal
Utility of Dollar Utility of
Total Utility Marginal 𝑴𝑼𝒙 Total Utility Marginal 𝑴𝑼𝒚
Qx (TU) Utility (MU) QY (TU) Utility (MU) Dollar 𝑷𝒚
𝑷𝒙
1 34 1 55
2 54 2 95
3 66 3 125
4 76 4 153
5 84 5 172

If the prices of X,Y are 2$ , 10$ respectively, and the consumer's income about 30$
Required: Fill the blank in the above table, and calculate the consumer equilibrium?