KRUGMAN'SMICROECONOMICS for AP*

Utility Maximization

Margaret Ray and David Anderson

Micro:

Econ:

15

51

Module

What you will learnin this Module:

• How consumers make choices about the purchase of goods and services

• Why a consumer’s goal is to maximizing utility

• Why the principle of diminishing marginal utility applies to the consumption of most goods and services

• How to use marginal analysis to find the optimal consumption bundle

Maximizing utility

In the Theory of Consumer Choice, consumers’ goal is to maximize their utility.

Utility

• Utility: a measure of the satisfaction the consumer derives from consumption of goods and services.

• Utility and Consumption

• The principle of diminishing marginal utility – Definition of 'Law Of Diminishing Marginal Utility‘Definition of 'Law Of Diminishing Marginal Utility‘

A law of economics stating that as a person increases A law of economics stating that as a person increases consumption of a product - while keeping consumption of consumption of a product - while keeping consumption of other products constant - there is a decline in the other products constant - there is a decline in the marginal utility that person derives from consuming each marginal utility that person derives from consuming each additional unit of that product.additional unit of that product.

Budgets

• The budget line

• The optimal consumption bundle

Good Y

B

A

C

Good X

The consumer’s The consumer’s challenge is two-challenge is two-fold:fold:

1. Find the bundles 1. Find the bundles of goods that are of goods that are affordable, given affordable, given income and prices, income and prices, andand2.2.Choose the bundle Choose the bundle that provides the that provides the highest utilityhighest utility..

Spending the Marginal Dollar

• Marginal utility

• MU per dollar

• Optimal consumption

The “utility maximization The “utility maximization rule” says that the consumer rule” says that the consumer should spend all of his should spend all of his income on two goods such income on two goods such that:that:  MU/P is equal for both (all) MU/P is equal for both (all) goods.goods.  As long as one good provides As long as one good provides more utility per dollar than more utility per dollar than another, the consumer will another, the consumer will buy more of the first good; as buy more of the first good; as more of the first product is more of the first product is bought, its marginal utility bought, its marginal utility diminishes until the amount diminishes until the amount of utility per dollar just of utility per dollar just equals that of the other equals that of the other product.product.

Figure 51.1 Cassie’s Total Utility and Marginal UtilityRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Definition of 'Law Of Diminishing Definition of 'Law Of Diminishing Marginal Utility‘Marginal Utility‘

A law of economics stating that as A law of economics stating that as a person increases consumption of a person increases consumption of a product - while keeping a product - while keeping consumption of other products consumption of other products constant - there is a decline in the constant - there is a decline in the marginal utility that person derives marginal utility that person derives from consuming each additional from consuming each additional unit of that product.unit of that product.

Figure 51.2 The Budget LineRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Table 51.1 Sammy’s Utility from Clam and Potato ConsumptionRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Table 51.2 Sammy’s Budget and Total UtilityRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Figure 51.3 Optimal Consumption BundleRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Table 51.3 Sammy’s Marginal Utility per DollarRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers

Figure 51.4 Marginal Utility per DollarRay and Anderson: Krugman’s Economics for AP, First EditionCopyright © 2011 by Worth Publishers