C h a p t e r

7 UTILITY AND
DEMAND

Key Concepts FIGURE 7.1

A Budget Line
„ Household Consumption Choices

Soda (six-packs per month)

Consumption choices are determined by the interaction 5
of the household’s consumption possibilities and its
preferences.
4
♦ Consumption possibilities — the household’s pur-
chases are limited by its income and by the prices of 3
the goods and services. A budget line, as illustrated
in Figure 7.1, shows the limits to what the house-
2
hold can purchase.
♦ Preferences — an individual’s likes and dislikes.
1
Preferences are measured by utility. Utility is the bene-
fit or satisfaction from consumption of a good or serv-
ice. 0 1 2 3 4 5 6
♦ Total utility is the total benefit from consumption Movies (per month)
of goods and services.
♦ Marginal utility (MU ) is the change in total utility ♦ the marginal utility per dollar spent, which is the
from a one-unit increase in the quantity of a good marginal utility from a good divided by its price, is
consumed. MU is positive, but because of dimin- equal for all goods.
ishing marginal utility, falls as the consumption of In terms of a formula, for the choice between two
the good increases. goods, sodas and movies, the second requirement for
maximizing utility is:
MU m MU s
„ Maximizing Utility =
Pm Ps
Consumers strive to obtain the most total utility possi-
ble; they maximize their total utility. A consumer with MU m the marginal utility from an additional
equilibrium occurs when all the consumer’s income is movie, Pm the price of a movie, and MU s and Ps the
allocated among different products so that the combi- analogous variables for soda.
nation of products maximizes the consumer’s total util- Equating the marginal utilities per dollar is an example
ity. of marginal analysis. Marginal analysis says that if the
Total utility is maximized when: marginal gain from an action exceeds the marginal loss,
♦ all the consumer’s income is spent; and take the action.
117
118 CHAPTER 7

„ Predictions of Marginal Utility Theory Helpful Hints

♦ A fall in the price of a movie raises the marginal
utility per dollar spent on movies. Consumers in- 1. THE MEANING OF CONSUMER EQUILIBRIUM :
crease the quantity of movies viewed as they substi- This chapter introduces another equilibrium,
tute movies for sodas. There is a movement along namely, the consumer equilibrium. What does con-
the downward sloping demand curve for movies. sumer equilibrium mean? Recall that the general
The demand curve for soda, a substitute for movies, definition of equilibrium is a situation “where op-
shifts leftward. posing forces balance.” When that occurs, there is
♦ A rise in the price of soda results in a decrease in the no incentive for any changes. In the supply and
quantity of sodas consumed. There is an upward demand model, equilibrium is attained at the price
movement along the negatively sloped demand at which the quantity supplied equals the quantity
curve for soda. The demand curve for movies, a sub- demanded. At that price neither demanders nor
stitute for soda, shifts rightward. suppliers have an incentive to change their behav-
♦ Movies and soda are normal goods, so an increase in ior. Consumer equilibrium is similar. When the
income increases the consumption of both products equilibrium conditions are satisfied, the consumer
and thereby increases the demand for both prod- has the most total utility that can be attained. The
ucts. consumer therefore has no incentive to change the
The individual demand is the relationship between the combination of goods consumed.
price of an item and the quantity demanded by an indi- 2. THE MARGINAL UTILITY PER DOLLAR FORMULA :
vidual. The market demand is the relationship be- One condition for consumer equilibrium is that the
tween the price of an item and the total quantity de- marginal utility per dollar spent on a good must
manded. The market demand curve is the horizontal equal the marginal utility per dollar of the other
sum of the individual demand curves. goods. In terms of a formula, for two goods, X and
If the marginal utility of a product diminishes only a Y, the requirement is that the consumer allocate his
little as the quantity consumed increases, the demand or her income so that
for the product is elastic; if it diminishes rapidly as the MU X MU Y
= .
quantity consumed increases, the demand is inelastic. PX PY
Why is this condition necessary for consumer equi-
„ Efficiency, Price, and Value librium? Recall that the term MU X P X is the
♦ A consumer is using resources efficiently by buying marginal utility per dollar spent on good X so it is
the goods and services that maximizes his or her the utility gained if spending on X is increased a
utility. dollar or the utility lost if spending on X is de-
♦ The marginal benefit from a good is the maximum creased by a dollar. MU Y P Y tells us similar in-
price a consumer is willing to pay for another unit formation about Y. Anytime there is an inequality
of the good when the consumer is maximizing his or between the marginal utility per dollar spent on
her utility. different goods, the consumer can increase his or
♦ The distinction between total utility and marginal her total utility by buying less of the product with
utility solves the paradox of value. Diamonds are the low MU P and by buying more of the good
less useful than water (that is, they have lower total with the high MU P . Only when the marginal
utility), but diamonds have a higher price since they utilities per dollar are equal does the consumer not
have higher marginal utility because most people gain by rearranging the consumption bundle. As a
have only a few diamonds. Water is more useful (it result, only when this equality holds (and the con-
has higher total utility), but has a lower price since sumer spends all his or her income) is the consumer
it has a lower marginal utility because the quantity in equilibrium by obtaining the maximum possible
of water consumed is large. total utility.
 UTILITY AND DEMAND 119

Questions Efficiency, Price, and Value

14. Marginal utility theory shows that goods with high
prices (such as diamonds) have high total utilities.
„ True/False and Explain 15. By maximizing his or her utility, a consumer uses
Household Consumption Choices his or resources efficiently.
11. A budget line shows the different combinations of
goods and services a consumer can afford to buy.
„ Multiple Choice
12. Utility measures a consumer’s level of satisfaction.
Household Consumption Choices
13. Marginal utility measures the additional utility 11. A household’s consumption choices are determined
from consuming an additional unit of a good. by
14. As more of a good is consumed, diminishing mar- a. prices of goods and services.
ginal utility means that the total utility from the b. its income.
good diminishes. c. its preferences.
d. all of the above.
Maximizing Utility
15. Economists assume that households choose their 12. A household’s consumption is limited by
consumption to maximize their marginal utility per a. its preferences.
dollar spent. b. only its income.
16. The marginal utility per dollar spent on a soda is c. only the prices it pays for what it buys.
MU s Ps where MU s is the marginal utility from d. both its income and the prices it pays for what it
a soda and Ps is the price of a soda. buys.

17. If the marginal utilities from consuming two goods 13. Which of the following is NOT an assumption of
are equal and the consumer is spending all of his or marginal utility theory?
her income, the consumer is in equilibrium. a. People derive utility from their consumption.
18. A household is maximizing its utility if the mar- b. More consumption yields more total utility.
ginal utility per dollar spent is equal for all goods c. Marginal utility diminishes with more consump-
and the household spends all its income. tion.
d. Utility can be measured and the units of utility
19. If the marginal utility per dollar spent on pizza are precisely defined.
exceeds the marginal utility per dollar spent on ta-
cos, total utility rises by increasing consumption of 14. As more of a good is consumed,
pizza and decreasing consumption of tacos. a. both the marginal utility and total utility from
Predictions of Marginal Utility Theory the good rise.
b. the marginal utility from the good rises and the
10. Marginal utility theory predicts that when the price
total utility falls.
of a product rises, a consumer buys more because
c. the marginal utility from the good falls and the
the marginal utility from the product is larger.
total utility rises.
11. An individual demand curve shows the total market d. both the marginal utility and total utility from
demand for an individual product. the good fall.
12. The market demand curve is the horizontal sum of
Maximizing Utility
all individual demand curves.
15. Economists assume that consumers’ objective is to
13. If the marginal utility from a good diminishes rap- a. maximize their total utility.
idly as more is consumed, demand for the good is b. maximize their marginal utility.
inelastic. c. maximize their income.
d. none of the above.
120 CHAPTER 7

16. Andrew finds that the marginal utility from a BMW 10. Amy’s income rises to $16. She continues to buy
exceeds that from a slice of pizza. Andrew is spend- only law books and yellow paper pads and she con-
ing all of his income. These conditions mean that tinues to maximize her utility. How many yellow
Andrew paper pads does she buy after her income increases?
a. is not maximizing his utility. a. 0
b. is maximizing his utility. b. 1
c. must increase his income in order to maximize c. 2
his utility. d. 3
d. might be maximizing his utility, but we cannot
tell without more information. 11. After Amy’s income rises to $16, what is her total
utility?
17. When Kelly maximizes her utility, she spends all of a. 82
her income and makes sure that the b. 64
a. marginal utility of each good she buys is as high c. 40
as possible. d. 36
b. marginal utility of each good she buys is equal.
c. amount of each good she buys is the same. 12. Bobby buys only soda and pizza and is buying the
d. marginal utility of a good divided by its price is amounts that maximize his utility. The marginal
equal for each good she buys. utility from a soda is 10, and the price of the soda is
$1. The marginal utility from a slice of pizza is 20.
Use the following table for the next four questions. The price of a slice of pizza must be
a. $20.
TABLE 7.1
b. $2.
Multiple Choice Questions 8, 9, 10, 11 c. $1.
Marginal utility
d. some amount that cannot be calculated without
more information.
Quantity Law books Paper pads
1 12 16 13. Meg buys only soda and pizza and is buying the
2 10 12 amounts that maximize her utility. The marginal
3 8 8 utility from a soda is 30 and the price of the soda is
4 6 4 $1. The marginal utility from a slice of pizza is 60.
5 4 2 The price of a slice of pizza must be
a. $20.
18. Amy spends her entire income of $10 on law books b. $2.
and yellow paper pads. Law books cost $2 and paper c. $1.
pads cost $4. The marginal utility of each good is d. some amount that cannot be calculated without
given in Table 7.1. If Amy is maximizing her utility, more information.
how many yellow paper pads does she buy?
a. 0 14. If Soula is maximizing her utility, when two goods
b. 1 have the same price she will
c. 2 a. buy only one.
d. 3 b. buy equal quantities of both.
c. get the same marginal utility from each.
19. Amy’s total utility at her consumer equilibrium is d. get the same total utility from each.
a. 82
b. 48
c. 46
d. 40
 UTILITY AND DEMAND 121

Predictions of Marginal Utility Theory 19. Which of the following statements is true?
15. Marginal utility theory predicts that a rise in the a. Marginal utility theory predicts that an increase
price of a banana leads to in a consumer’s income increases consumption of
a. the demand curve for bananas shifting rightward. all goods.
b. the demand curve for bananas shifting leftward. b. It is possible to derive the law of demand — that
c. a movement upward along the demand curve for a higher price decreases the quantity demanded
bananas. — using marginal utility theory.
d. a movement downward along the demand curve c. Marginal utility theory makes no prediction
for bananas. about a consumer’s responses to hikes in the
prices of the goods and services he or she con-
16. Lisa buys only compact discs and tapes and spends sumes.
all her income. The marginal utility from a compact d. Marginal utility theory predicts that all goods are
disc is 30 and the marginal utility from a tape is 20. normal goods and that all goods are substitutes
The price of a compact disc is $15 and the price of a for each other.
tape is $10. To maximize her utility, Lisa should
a. increase her consumption of compact discs. 20. The marginal utility from gasoline diminishes very
b. increase her consumption of tapes. rapidly. As a result, the
c. not change her consumption of compact discs a. demand curve for gasoline is upward sloping and
and tapes. very steep.
d. lower the price of a tape. b. demand for gasoline is price inelastic.
c. demand for gasoline is price elastic.
17. Michael consumes only steak and lobster. Suppose d. consumer surplus from gasoline is likely to be
that the price of a steak rises but Michael’s income nonexistent.
does not change. After he is back at a consumer
equilibrium, compared to the situation when steak Efficiency, Price, and Value
was cheaper, the marginal utility from the last steak 21. The fact that rubies are more expensive than milk
will reflects the fact that for most consumers
a. have increased. a. the total utility from rubies exceeds that from
b. have not changed. milk.
c. have decreased. b. the marginal utility from rubies equals that from
d. not be comparable with the marginal utility from milk.
before the price hike. c. more milk is consumed than rubies.
d. a quart of rubies is prettier than a quart of milk.
18. Michael consumes only steak and lobster. Both are
normal goods. Michael’s income increases but the 22. The principle of diminishing marginal utility means
prices of neither steak nor lobster change. After he is that the consumer surplus from the second slice of
back at equilibrium, compared to the situation when pizza is
Michael’s income was less, the marginal utility from a. greater than that from the first.
the last steak will b. equal to that from the first.
a. have increased. c. less than that from the first.
b. have not changed. d. not comparable to that from the first.
c. have decreased.
d. not be comparable with the marginal utility from
before the increase in income.
122 CHAPTER 7

FIGURE 7.2 FIGURE 7.3

Multiple Choice Question 23 Short Answer Problem 2

S2
Price (dollars)

Price (cents per pound of fish sticks)

S1
90

3
80
A

2 70

60
1 B
C 50
D

2 4 6 8
0 8 9 10 11 12 13
Quantity (units per month)
Quantity (thousands of pounds of fish sticks a month)

23. In Figure 7.2 the consumer is buying 4 units at a

price of $2 each. Consumer surplus is the area 3. Loren is in equilibrium, spending her income of
marked $200 buying 2 video games at a price of $40 each
and 8 compact discs at a price of $15 each. Then,
a. A
inflation causes the price of a compact disc and a
b. B
video game to double (to $80 and $30, respec-
c. C
tively) while Loren’s income also doubles (to
d. None of the above.
$400). What happens to Loren’s purchases of video
„ Short Answer Problems games and compact discs: Do both increase, de-
crease, not change, or change in some direction that
1. Explain how the consumer equilibrium condition cannot be determined?
and the principle of diminishing marginal utility
can be used to derive the law of demand. TABLE 7.2
2. Jake consumes only fish sticks and broccoli. He is Short Answer Problem 4
initially maximizing his utility, so he spends all of
his income on fish sticks and broccoli and sets Marginal utility
MU FS MU B Quantity Bats Lizards
=
PFS PB 1 20 50
2 18 44
with MU FS the marginal utility from fish sticks;
3 14 36
P FS the price of fish sticks; MU B the marginal
4 8 26
utility from broccoli; and PB the price of broccoli.
The price of fish sticks rises (from 70 cents a pound
to 80 cents) as a result of the shift in the supply 4. Igor maximizes his utility by spending his entire
curve shown in Figure 7.3. Use the condition for income of $16 on bats and lizards. Table 7.2 has
utility maximization to explain how Jake will move Igor’s marginal utility from each good. The price of
to a new utility-maximizing consumer equilibrium. a bat is $2, and he buys 2 bats. The marginal utility
Also show the connection between your explana- from the last lizard he buys is 36.
tion and the change in the figure from 11,000 a. Calculate the price of a lizard two ways.
pounds of fish sticks being consumed to 10,000 b. What is Igor’s total utility?
pounds. c. Igor could buy 4 lizards. If he did so and also
purchased the maximum number of bats possi-
 UTILITY AND DEMAND 123

ble given his income, what would be his total

TABLE 7.5
utility then?
d. The marginal utility of even the fourth lizard Liz’s Marginal Utilities per Dollar
exceeds the marginal utility from the first bat;
Bags of
yet when maximizing his utility, Igor nonethe- popcorn MU P Candy bars MU P
less buys some bats. Explain why Igor buys 1 ____ 1 ____
some bats. (Hint: Igor is not batty.)
2 ____ 2 ____
3 ____ 3 ____
TABLE 7.3
4 ____ 4 ____
Liz’s Utility from Popcorn 5 ____ 5 ____

Bags of Marginal utility 6 ____ 6 ____

popcorn Total utility from last bag
0 0 XX d. In part (c), what is Liz’s total utility?
1 20 20 e. Now suppose that Liz consumes 3 bags of pop-
2 36 16 corn and 2 candy bars. Explain why she is not
3 50 ___ maximizing her utility. Be sure to compare her
4 ___ 12 total utilities for the two consumption bundles
5 72 ___ — your answer to part (c) and the 3 bags of
6 80 ___
popcorn, 2 candy bars used in this question.
Also use the MU P terms to explain why con-
suming 3 bags of popcorn and 2 candy bars is
not optimal.
TABLE 7.4
6. Suppose that Liz’s utility remains as it is in Problem
Liz’s Utility from Candy Bars
5 but the price of a candy bar doubles to $1. The
Marginal utility price of a bag of popcorn, however, does not
Candy bars Total utility from last bar change — it remains equal to $1 per bag.
0 0 XX a. Construct a new table (similar to Table 7.5) of
1 14 14 the marginal utility per dollar for popcorn and
2 26 12 candy bars.
3 ___ 10 b. Liz’s allowance continues to be $4. After the
4 44 ___ price change, how much popcorn and how
5 51 ___ many candy bars will she consume each week?
6 57 ___ c. Are popcorn and candy bars substitutes or com-
plements for Liz? Why?
5. Tables 7.3 and 7.4 give Liz’s utility from her con- d. Based on the information you have obtained,
sumption of popcorn and candy. draw Liz’s demand curve for candy bars.
a. Complete Tables 7.3 and 7.4. 17. Lori has $40 a week that she spends on playing
b. Suppose that the price of a bag of popcorn is $1 tennis and buying comic books. A set of tennis
and that the price of a candy bar is $0.50. Use costs $1 and a comic book costs $2. One week
the information in Tables 7.3 and 7.4 to com- when Lori spent all her income, she found that the
plete Table 7.5. There MU P means marginal marginal utility from the last set of tennis was 16
utility divided by price, which is equivalent to and that the marginal utility from the last comic
marginal utility per dollar spent. book was 20.
c. Liz’s weekly allowance is $4. If she spends her a. Show that Lori’s choice of tennis sets and comic
entire allowance on popcorn and candy, how books was not optimal.
much popcorn and how many candy bars will b. To increase her utility, which good should Lori
Liz consume each week? consume more of and which less?
124 CHAPTER 7

TABLE 7.6 „ You’re the Teacher

Short Answer Problem 8 1. “This whole idea of marginal utility is stupid. I
mean, after all, who goes into a store and calculates
Quantity demanded the marginal utility from something before deciding
(pounds per week)
to buy it? I just look at something, look at the price,
Price (dollars think about how much money I’ve got in my
per pound) Alice Bob Carol Market
pocket, and then decide whether or not to buy the
$0.50 10 4 10 ____ thing. No one I know calculates marginal utilities
0.75 9 2 7 ____ when they go shopping, so why do I have to learn
1.00 8 0 4 ____ this stuff?” What response do you make to your
1.25 7 0 1 ____ classmate? (Don’t agree!)
2. “One thing I don’t understand about all this mate-
18. Table 7.6 shows Alice’s, Bob’s, and Carol’s demand rial dealing with consumers and their choices is
schedules for rutabagas (a turnip-like vegetable that how I am supposed to think about products like
is one of Canada’s main exports). apartments. Suppose that the rent in my apartment
a. Assume that Alice, Bob, and Carol comprise the goes up. Marginal utility theory says that I will con-
entire market and complete the table by calcu- sume fewer apartments. But what does this mean?
lating the market demand schedule. I’ll still rent one apartment. And, if rent goes down,
I sure won’t go out and rent two! How does mar-
b. On a single diagram, draw the individual de-
ginal utility theory account for this fact?” Your
mand curves for Alice, Bob, and Carol, as well
friend has come up with a good question; provide
as the market demand curve.
an equally good explanation to help your friend
19. What is the relationship between price elasticity understand this point.
and how rapidly marginal utility diminishes as
more of a good is consumed? Why does this rela-
tionship exist?
10. How does marginal utility theory resolve the dia-
mond / water paradox of value?
 UTILITY AND DEMAND 125

Answers 15. T By maximizing his or her utility, the person is

consuming the combination of goods and serv-
ices that gives him or her the highest value,
„ True/False Answers which means no resources are wasted.
Household Consumption Choices
11. T The budget line shows the limits to what a con- „ Multiple Choice Answers
sumer can afford to purchase. Household Consumption Choices
12. T Utility measures an individual’s satisfaction 11. d A household’s consumption is determined by its
without any regard to the prices of the items or preferences, its income, and prices of goods.
the person’s income. 12. d A household’s consumption purchases are lim-
13. T As this definition stresses, marginal utility is the ited by its budget, which depends on the house-
extra utility from an extra unit of a good. hold’s income and the prices of the goods and
14. F The principle of diminishing marginal utility services it buys.
implies that the marginal utility from additional 13. d Utility cannot be measured, so its units cannot
units declines. be precisely defined.
14. c The marginal utility diminishes and, as a result,
Maximizing Utility total utility increases but by less as each addi-
15. F Economists assume that households maximize tional unit of the good is consumed.
their total utility.
16. T The question presents the definition of marginal Maximizing Utility
utility per dollar. 15. a By maximizing their total utilities, people make
17. F To be in equilibrium, the marginal utilities di- themselves as well off as possible.
vided by the prices, MU P, must be equal. 16. d If Andrew is maximizing his utility, we know
18. T These are the two conditions necessary for a that MU pizza Ppizza = MU BMW P BMW but
household to maximize its utility. without information about the price of a BMW
19. T In this case, the gain in utility from consuming and a pizza, we cannot determine whether this
one dollar more of pizza exceeds the loss in util- condition is satisfied.
ity from consuming one dollar less of tacos. 17. d To maximize her utility, Kelly consumes the
amounts of the different goods that equalize the
Predictions of Marginal Utility Theory marginal utility per dollar of each good.
10. F Marginal utility theory predicts that the quantity 18. b When Amy buys 1 yellow paper pad, she can
demanded of a product decreases when its price
buy 3 books. With this consumption bundle,
rises.
MU pad Ppad = 4 and MU book P book = 4.
11. F An individual demand curve shows one individ-
19. c Amy receives utility of 16 from yellow paper
ual’s demand for a product.
pads and 30 (12 + 10 + 8) from law books, for
12. T The market demand shows the demand from all total utility of 46.
individuals.
10. c Amy now buys 2 paper pads and 4 law books
13. T If the marginal utility declines rapidly, then because this combination of pads and books uses
when the price of the good changes it requires
all her income and sets MU pad Ppad =
only a small change in consumption of the good
to restore its marginal utility per dollar back to MU book P book = 3.
equality with the marginal utility per dollar for 11. b Amy has utility of 28 (16 +12) from yellow pa-
other goods. per pads and 36 (12 + 10 + 8 + 6) from law
books for total utility of 64.
Efficiency, Price, and Value
12. b To maximize his utility, Bobby must set
14. F Products with high prices must have high mar-
ginal utilities, not necessarily high total utilities. MU soda Psoda = MU pizza Ppizza . Because
126 CHAPTER 7

MU soda Psoda = 10 1 = 10, in order for 22. c Because the second slice of pizza is valued less
MU pizza Ppizza also to equal 10, with than the first because of diminishing marginal
MU pizza = 20, Ppizza = $2 . utility, consumer surplus from the second slice is
less than that from the first.
13. b The same reasoning outlined in the answer to
23. a Consumer surplus is the area under the demand
Question 12 applies and Ppizza = $2 . Even curve and above the price paid.
though Bobby’s and Meg’s marginal utilities are
not the same, nonetheless to maximize their
utility, both set MU soda Psoda equal to „ Answers to Short Answer Problems
MU pizza Ppizza . 1. Suppose that an individual in consumer equilibrium
14. c Because MU P is equal for all goods, if two consumes only two goods, X 0 units of good X and
products have the same P, they must have the Y0 units of good Y. Therefore at consumption lev-
same MU. els X 0 and Y 0 , the marginal utility per dollar spent
on X equals the marginal utility per dollar spent on
Predictions of Marginal Utility Theory Y. If the price of X rises, how does the consumer re-
15. c With a higher price for a banana, consumers spond? The marginal utility per dollar spent on X
decrease the quantity they consume, which raises declines and becomes less than the marginal utility
the marginal utility of bananas. per dollar spent on Y. To restore equilibrium, the
16. c MU CDs PCDs = MU tape Ptape . Lisa is already consumer must increase the marginal utility of X
maximizing her utility. and decrease the marginal utility of Y. From the
principle of diminishing marginal utility, the only
17. a Michael consumes fewer steaks, so the marginal
way to do so is to decrease the consumption of X
utility from the last steak he consumes is higher.
and increase the consumption of Y. This action,
18. c Michael consumes more steak because steak is a then, demonstrates the law of demand: A rise in the
normal good. Because he consumes more steak, price of X results in a decrease in the consumption
the marginal utility from the last steak he con- of X.
sumes is lower than before. 2. When the price of a fish stick rises,
19. b By making assumptions about people’s behavior MU FS MUB
— that they aim to obtain the maximum total < .
utility and that their marginal utility diminishes PFS PB
as they consume more of a product — it is pos- Jake no longer is in equilibrium because the utility
sible to derive the law of demand. per dollar spent on fish sticks is less than that for
20. b Consider a large fall in the price of gasoline. To broccoli. So Jake increases his total utility by
bring MU gas Pgas back to equality with spending fewer dollars on fish sticks and more on
MU P for other goods, more gasoline will be broccoli. These changes make MUF S rise and
MUB fall, which will eventually result in equality
consumed, which lowers MU gas . If the mar-
between the marginal utility per dollar spent on fish
ginal utility declines rapidly as more gasoline is sticks and broccoli. Jake’s decreased consumption of
consumed, only a little more gasoline is con- fish sticks moves him along his individual demand
sumed before MU gas falls enough so that curve for fish sticks. Indeed, consumers in general
MU gas Pgas equals MU P for everything decrease the quantity of fish sticks they consume,
else. As a result, the large fall in the price of which accounts for the movement along the market
gasoline leads to only a small increase in the demand curve in the figure from the initial equilib-
quantity demanded. rium (with 11,000 pounds of fish sticks produced
and consumed) to the new equilibrium (with only
Efficiency, Price, and Value 10,000 pounds of fish sticks produced and con-
21. c Because more milk is consumed, the MU from sumed).
milk is lower than the MU from rubies. 3. After the inflation Loren still purchases 2 video
games and 8 compact discs. Loren buys the combi-
 UTILITY AND DEMAND 127

nation of games and CDs that maximizes her utility, We know that MU l = 36, P b = $2, and, if Igor
setting MU games Pgames = MU CDs PCDs and buys 2 bats, that MU b = 18. Substituting these
spending all her income. For the first requirement, values, we solve for P l :
before the inflation the combination of 2 games and 36 18
=
8 CDs maximized Loren’s utility so that it was the P l $2
case that MU games Pgames = MU CDs PCDs . Af- 36
= Pl
ter the inflation, the marginal utilities do not 9
change, but the prices double. So, MU P for $4 = P l
games equals MU games (2 × Pgames ) and MU P b. Igor receives total utility of 38 from his bats
(20 + 18) and total utility of 130 from his lizards
for CDs equals MU CDs (2 × PCDs ). The MU P (50 + 44 + 36). Igor’s overall total utility from
for video games is half what it was before, as is the bats and lizards is 168.
MU P for compact discs. Because they were equal c. If Igor buys 4 lizards, because each lizard costs
before the inflation, dividing each by 2 does not $4, he spends all his income and so can purchase
change their equality; that is, after the inflation the no bats. In this case, Igor’s total utility is 156
equality of the marginal utilities per dollar condition (50 + 44 + 36 + 26).
for utility maximization is still met. For the second d. Even though each bat returns less marginal util-
condition, that all income is spent, after the infla- ity than a lizard, bats are less expensive then liz-
tion, buying 2 video games and 8 compact discs uses ards. So when Igor is selecting his utility-
up all of Loren’s income, so the second criteria is maximizing combination of bats and lizards, the
met. The combination of 2 games and 8 CDs con- cheapness of bats means that he will buy some.
tinues to maximize Loren’s utility, so that is the For example, compare Igor’s total utility when
combination she will purchase. he buys 2 bats and 3 lizards, given in part (b) as
4. a. One of two methods for calculating the price of 168, with his total utility when he buys 0 bats
a lizard is based on the fact that Igor spends all and 4 lizards, computed in part (c) as 156.
his income on bats and lizards. This fact means Clearly Igor’s total utility is higher when he buys
that: 2 bats and 3 lizards than when he concentrates
solely on lizards by purchasing 4 lizards and 0
Y = Pb × Q b + Pl × Q l
bats.
where Y is Igor’s income, P b is the price of a bat,
5. a. Tables 7.7 and 7.8 (on the next page) are com-
Q b is the quantity of bats bought, Pl i s the
pleted versions of Tables 7.3 and 7.4, respec-
price of a lizard, and Q l is the quantity of lizards
tively.
purchased. We know that Y = $16, P b = $2,
Q b = 2, and, if the marginal utility of the last b. Table 7.9 (on the next page) completes Table
lizard is 36, that Q l = 3. Substituting these val- 7.5.
ues, we solve for P l :
TABLE 7.7
$16 = $2 × 2 + P l × 3
Liz’s Utility from Popcorn
$12 = P l × 3
Bags of Marginal utility
$4 = P l popcorn Total utility from last bag
The second way to determine the price of a liz- 0 0 XX
ard uses the condition for utility maximization, 1 20 20
that the marginal utility per dollar spent on a liz- 2 36 16
ard equals the marginal utility per dollar spent 3 50 14
on a bat. In terms of a formula, we have that
4 62 12
MU l MU b
= . 5 72 10
Pl Pb 6 80 8
128 CHAPTER 7

TABLE 7.8 TABLE 7.10

Liz’s Utility from Candy Bars Liz’s (New) Marginal Utilities Per Dollar
Marginal utility Bags of
Candy bars Total utility from last bar popcorn MU P Candy bars MU P
0 0 XX 1 20 1 14
1 14 14 2 16 2 12
2 26 12 3 14 3 10
3 36 10 4 12 4 8
4 44 8 5 10 5 7
5 51 7 6 8 6 6
6 57 6
6. a. Table 7.10 shows Liz’s MU P for popcorn and
TABLE 7.9 candy after the price hike for candy. The price
rise did not change Liz’s MUs.
Liz’s Marginal Utilities Per Dollar
b. Liz will consume 3 bags of popcorn and 1 candy
Bags of bar. This combination of popcorn and candy
popcorn MU P Candy bars MU P spends all of Liz’s income ($4), and the marginal
1 20 1 28 utility per dollar spent is the same for popcorn
2 16 2 24 and candy bars (14).
3 14 3 20 c. Popcorn and candy bars are substitutes for Liz
4 12 4 16 because a rise in the price of a candy bar leads to
5 10 5 14 an increase in the demand for popcorn.
6 8 6 12 d. Two points on Liz’s demand curve have been
identified. When the price of a candy bar is $1,
c. 2 bags of popcorn and 4 candy bars. This com- 1 candy bar will be demanded, and when the
bination uses up all of Liz’s income and also price is $0.50, 4 candy bars will be demanded.
equates the marginal utility per dollar spent on The demand curve is a line through these two
popcorn and candy bars (16). points, as illustrated in Figure 7.4.
d. Total utility is the utility from the consumption
of 2 bags of popcorn (36) plus the utility from FIGURE 7.4
the consumption of 4 candy bars (44) or 80. Short Answer Problem 6
e. If Liz consumed 3 bags of popcorn and 2 candy
Price (dollars per candy bar)

bars, total utility would be 76, less than 80, the

total utility from the consumption of 2 bags of 1.25
popcorn and 4 candy bars. For the combination
of 3 bags of popcorn and 2 candy bars, MU P 1.00
for popcorn is 14 and MU P for candy bars is
24. Because MU P is not the same for both .75
goods, this combination does not maximize Liz’s
utility. More specifically, Liz could decrease her
.50
consumption of popcorn by a dollar, use the
dollar to buy more candy bars, and thereby
would raise her total utility. This marginal analy- .25
DLiz
sis shows that Liz can increase her total utility by
consuming less popcorn and more candy when- 0 1 2 3 4 5 6
ever the MU P from popcorn is less than Quantity (candy bars per week)
the MU P from candy bars.
 UTILITY AND DEMAND 129

7. a. Lori is not maximizing her utility because the FIGURE 7.5

marginal utility per dollar spent on the set of Short Answer Problem 8
tennis (16 $1 = 16 ) is not the same as the mar-
ginal utility per dollar spent on comic books

Price (dollars per pound of rutabagas)

( 20 $2 = 10 ).
b. To equate the marginal utilities per dollar spent 1.25

(and by so doing increase her total utility), Lori

will increase her consumption of tennis and de- 1.00
crease her consumption of comic books. To
show that this change raises her utility, we can .75
use marginal analysis. By cutting back a dollar DAlice
on comic books, Lori loses 10 units of utility; .50
DBob DCarol DMarket
but by then spending the dollar on tennis, Lori
gains 16 units. Therefore on net, Lori gains 6 .25
units of utility (16 gained from tennis minus 10
lost from comic books) by changing her con-
sumption bundle. 0 4 8 12 16 20 24
Quantity (pounds of rutabagas)

TABLE 7.11
Short Answer Problem 8 to rise (a lot) because P falls (a lot). In response to
the increase in the marginal utility per dollar spent
Price (dollars Market on sugar, people consume more sugar. This increase
per pound) demand in consumption reduces sugar’s marginal utility, and
0.50 24 the MU P from sugar falls. Enough additional
0.75 18 sugar will be consumed so that the MU P from
1.00 12 sugar falls back to equality with the MU P from all
1.25 8 other products. How much additional sugar con-
sumption is required? Because the marginal utility
from sugar falls rapidly as more sugar is consumed,
8. a. Table 7.11 gives the market demand. For an
not very much more sugar must be consumed in or-
example of how to calculate these answers, at the
der to reduce substantially the MU P of sugar. So
price of $0.50 per pound, the market demand is
when the marginal utility from a good diminishes
24, with 10 demanded by Alice plus 4 de-
rapidly as more is consumed, a large price change
manded by Bob plus 10 demanded by Carol.
brings only a small change in the quantity de-
b. Figure 7.5 shows the three individual demand
manded, which means that the demand for the
curves and the market demand curve, the sum of
product is price inelastic.
Alice’s plus Bob’s plus Carol’s demand.
[Link] paradox of value is resolved by recognizing the
9. The more rapidly the marginal utility from a good
difference between the total utility from a product
diminishes as more of the good is consumed, the
and its marginal utility. For instance, the total util-
less elastic is the demand for the product. Con-
ity from consumption of water is large but because
versely, the less rapidly the marginal utility dimin-
we consume a lot of water, the marginal utility from
ishes, the more elastic is the demand for the prod-
the last gallon of water is small. The total utility
uct. For an example, take the case of sugar. The
from the consumption of diamonds is small, but be-
marginal utility of sugar diminishes rapidly as more
cause we consume few diamonds, the marginal util-
units of it are consumed. Initially consumers set
ity of the last diamond is large. In consumer equilib-
the MU P from sugar equal to the MU P for all
rium, because the marginal utility per dollar spent is
other products. Suppose that the price of sugar falls
the same for water and diamonds, the price of water
by a substantial amount. This change causes the
must be low and the price of a diamond must be
marginal utility per dollar spent on sugar, MU P ,
high. The paradox of value is solved because it is the
130 CHAPTER 7

marginal utilities — not the total utilities — that 2. “What you are missing is the fact that apartments
are related to the price of diamonds and water. are not all identical. My apartment is larger than
„ You’re the Teacher yours. If the price of an apartment rose — rents go
up — I’d move to a smaller apartment. Or, if the
1. “You’re right that no one goes into a store and cal- price went down, I wouldn’t rent two apartments,
culates marginal utility before deciding whether to but I’d move to a still larger one. So think about it
buy something. But that is missing the point of this way: If the price of an apartment goes up, we’ll
marginal utility theory. Marginal utility theory is not consume ‘fewer’ apartments by renting smaller
trying to explain how people make decisions about apartments; and, if the price goes down, we’ll con-
what to buy. Instead, it is based on the assumption sume ‘more’ apartments by renting larger ones.”
that people make themselves as well off as possible
— maximize their utility — to explain how people
respond to changes in prices and incomes. It’s not a
theory of people’s thoughts. It’s a theory of people’s
actions.”
 UTILITY AND DEMAND 131

Chapter Quiz 16. The statement that more consumption yields more
utility is
11. As Sam’s consumption of rice decreases, his a. a prediction of marginal utility theory.
a. average utility from rice falls. b. an assumption of marginal utility theory.
b. total utility from rice falls. c. a fallacy disproven by marginal utility theory.
c. marginal utility from rice decreases. d. true of goods but not of services.
d. elasticity of utility from rise increases.
17. Marginal utility theory predicts that an increase in
12. When Romona is in consumer equilibrium, the price of a good ____ the quantity demanded.
a. her marginal utilities from all goods are equal. a. increases
b. her total utilities from all goods are equal. b. has no effect on
c. her total utility per dollar from all goods are c. decreases
equal. d. perhaps increases, has no effect on, or decreases,
d. her marginal utility per dollar from all goods are depending on whether the good is a normal good
equal. or inferior good.

13. According to marginal utility theory, consumers 18. The market demand curve for rutabagas is
a. maximize their total utility and minimize their a. used to derive the individual demand curves.
marginal utility. b. the sum of the quantity demanded by each indi-
b. maximize their total utility given the prices of vidual at each price.
goods and their income. c. more elastic than any individual demand curve.
c. maximize their income. d. less elastic than any individual demand curve.
d. spend the most on least expensive goods.
19. Kathy is in consumer equilibrium and consumes
14. The price of a soda is $1 and the price of a movie is many goods. For her, purses are a normal good. An
$5. Bobby spends all of his income on sodas and increase in her income changes her to a new equilib-
movies. If Bobby’s marginal utility from a soda is 10 rium in which her consumer surplus from purses is
and his marginal utility from a movie is 20, to a. zero, as it was in the old equilibrium.
maximize his utility Bobby definitely ____ the b. positive and equal to what it was in the old equi-
number of movies he sees and ____ his consump- librium.
tion of sodas. c. lower than in the old equilibrium.
a. increases; increases d. higher than in the old equilibrium.
b. increases; decreases
10. Megan buys only soda and pizza and is buying the
c. decreases; increases
amounts that maximize her utility. The marginal
d. decreases; decreases
utility from a soda is 10 and the price of a soda is
15. When economists talk of inferior goods they mean $1. The marginal utility from a pizza is 80. Hence
only goods for which the price of a pizza must be
a. the demand curve slopes downward. a. $80.
b. marginal utility falls as more of the good is b. $10.
consumed. c. $8.
c. marginal utility is always negative. d. $4.
d. demand decreases when income rises.

The answers for this Chapter Quiz are on page 367

132