Chapter 8: Utility and Demand
Main points
• Explain the limits to consumption and describe preferences using the concept
of utility
• Explain the marginal utility theory and consumer choice.
• Use marginal analysis to predict the impact of changes in income and prices
on consumption possibilities
NOTE: The lecture notes must be used in conjunction with the textbook and tutorials
Consumption choices
The choices you make as a buyer of goods
and services is affected by:
1. Consumption possibilities
2. Preference
Consumption Possibilities:
➢ they are all the things that you can afford
to buy.
➢ they depend on your income and the
prices of the goods that you consume.
➢ A Consumer’s Budget Line is used to
express the consumption possibilities.
➢ Budget line shows the limits between
affordable and unaffordable choices
Consumption choices
We can afford any of the combinations at
points A to F.
▪ Some goods are indivisible and must be
bought in whole units at the points marked.
▪ Other goods are divisible goods and can be
bought in any quantity.
▪ The line through points A to F is Lisa’s budget
line.
▪ We can afford any point on the budget
line or inside it (affordable)
▪ We cannot afford any point outside
the budget line (unaffordable)
Consumption choices
• Consumption possibilities change
when income or prices change:
1. A rise in income shifts the budget
line outward but leaves its slope
unchanged (we can increase our
consumption of both goods).
2. A change in the price changes the
slope of the line (one good will be
cheaper than the other).
Consumption choices
Preferences
• However your choices are limited by your income
and the prices, but she still has lots of choices.
• The choice that she makes depends on her
preferences (what you like and dislike).
➢ Utility is your benefit or satisfaction from
consuming a good or service.
➢ Total utility is the total benefit a person gets
from consuming goods. Generally, more
consumption gives more total utility.
➢ Marginal utility is the change in total utility • As the quantity consumed of a good increases,
the marginal utility from it decreases
that results from a unit-increase in the quantity • This is known as the principle of diminishing
of the good consumed. marginal utility
Consumption choices
Positive Marginal Utility and negative
marginal utility
Positive marginal utility:
- is generated when total utility increases with
increasing consumption.
- all the goods people enjoy and want more of
have positive utility).
negative marginal utility:
- is generated when total utility decreases with
increasing consumption.
- Some objects yield negative marginal utility
(things with harmful impact such as polluted
air or water)
Utility-maximizing choices
• The key assumption is that the
household chooses the consumption
possibility that maximizes total utility.
• Two methods to compute utility-
maximizing choices (Spreadsheet
solution and Marginal solution)
Spreadsheet Solution:
make a table in a spreadsheet and
do the calculations.
▪ Find the just-affordable combinations
▪ Find the total utility for each just-
affordable combination
▪ The utility-maximizing combination is
the consumer’s choice
Utility-maximizing choices
Spreadsheet Solution:
1- Find Just-Affordable Combinations
▪ Lisa has $40 a month to spend on
movies and soda.
▪ The price of a movie is $8 and the
price of soda is $4 a case.
▪ Each row of Table 8.2 shows a
combination of movies and soda
that exhausts Lisa’s $40.
Affordable combination = combinations
that used all the available income to buy
both goods given the price of these goods
Utility-maximizing choices
Spreadsheet Solution:
2- Find the Total Utility for Each
Just-Affordable Combination
▪ When Lisa sees 1 movie and
drinks 8 cases of soda a
month,
▪ she gets 50 units of utility
from the 1 movie and 248
units of utility from the 8
cases of soda.
▪ Her total utility is 298 units.
Utility-maximizing choices
Spreadsheet Solution:
3- Consumer Equilibrium
▪ Lisa chooses the combination that
gives her the highest total utility.
▪ Lisa maximizes her total utility
when she sees
2 movies and drinks 6 cases of
soda a month.
▪ Lisa gets 90 units of utility from
the 2 movies and 225 units of ▪ Consumer equilibrium is the situation in
utility from the 6 cases of soda. which Lisa has allocated all of her available
income in a way that maximizes her total
utility, given the prices of movies and soda.
Utility-maximizing choices
Marginal analysis Solution:
A consumer’s utility is maximized when the consumer spends all
available income and equalizes marginal utility per dollar for all
goods.
•Choosing at the Margin
▪ Marginal utility is the increase in total utility that results from consuming
one more unit of the good.
▪ The marginal utility per dollar is the marginal utility of a good that results
from spending one more dollar on it.
▪ Marginal utility per dollar equals the marginal utility from a good divided
by its price
Utility-maximizing choices
Marginal analysis Solution:
Assume: Two goods, movies and books:
– marginal utility from movies (MUM ) and the price of a movie PM, then the marginal
utility per dollar from movies is MUM/PM .
– marginal utility of book MUb and the price of book Pb , then the marginal utility per
dollar from book is MUb/Pb.
–Find the point at which MUM/PM and MUb/Pb are equal
–Note that PM = $8 and Pb = $4
Marginal Marginal
Quantity of Marginal utility per Quantity Marginal utility per
movies utility dollar of books utility dollar
1 22 2.75 1 15 3.75
2 18 2.25 2 9 2.25
3 13 1.63 3 7 1.75
4 6 0.75 4 5 1.25
5 3 0.38 5 3 0.75