Ch.

19: Consumer Choice:

Maximizing Utility and
Behavioral Economics
Del Mar College
John Daly
2003 South-Western Publishing, A Division of Thomson Learning

Utility Theory, Total and Marginal

A good that gives you Utility is one that has the power
to satisfy wants, or that gives you satisfaction.
Diamond Water Paradox: The observation that those
things that have the greatest value in use sometimes
have little value in exchange and those things that have
little value in utility sometimes have the greatest value
in exchange.
Utils are an artificial construct used to measure utility.
Total Utility is the total satisfaction a person receives
from consuming a particular quantity of good.
Marginal Utility is the additional utility gained from
consuming an additional unit of some good.

Law of Diminishing Marginal

Utility
The law of
Diminishing Marginal
Utility states that for a
given time period, the
marginal utility gained
by consuming equal
successive units of a
good will decline as
the amount consumed
increases.

Total Utility, Marginal Utility, and the

Law of Diminishing Utility
The law of
diminishing
marginal
utility is based
on the idea
that if a good
has a variety
of uses but
only one unit
of the good is
available, then
the consumer
will use the
first unit to
satisfy his or
her most
urgent want.

Utility and the One-Hundredth

Game of Chess
Marginal utility begins to
decline with the second
unit of a good consumed.
The marginal utility
associated with consume
equal successive units of a
good will eventually
decline as the amount
consumed increases.

Interpersonal Utility Comparison

The utility obtained by
one person cannot be
scientifically or
objectively compared
with the utility
obtained from the
same thing by another
person because utility
is subjective.

The Solution to the DiamondWater Paradox

Goods have both Total
Utility and Marginal
Utility
The Total Utility of water
is high while the Total
Utility of Diamonds is
low.
The Marginal Utility of
water is low while the
Marginal Utility of
Diamonds is high

Is Gambling Worth The Effort?

Losing a dollar bet in a
fair game causes you
to lose more utility
than winning a dollar
causes you to gain
utility.
This is due to
diminishing marginal
utility.

Q&A
State and solve the diamond-water paradox.
If total utility is falling, what does this
imply for marginal utility? Give an a
mathematical example to illustrate your
answer.
When would the total utility of a good and
the marginal utility of a good be the same?

Consumer Equilibrium
Occurs when the
consumer has spent all
income and the
marginal utilities per
dollar spent on each
good purchased are
equal.

Consumer Equilibrium and

Demand
A consumer is
in equilibrium
when he or
she derives
the same
marginal
utility per
dollar for all
goods.

Income and Substitution Effects

A persons real income, or purchasing power, rises if with a given
absolute income, he or she can purchase more goods and services.
A fall in the relative price of a good will, and a rise in real income
can, lead to greater purchases of the good.
The portion of the change in the quantity demanded that is
attributable to a change in its relative price is referred to as the
substitution effect.
The portion of the change in the quantity demanded that is
attributable to a change in real income, brought about by a change
in absolute price, is referred to as the income effect.

Income and Substitution Effects

Should The Government Provide

Necessities of Life for Free?
Resources must be used to produce every unit of a
good consumed.
If the government uses scarce resources to provide
goods that have low marginal utility, then fewer
resources are available for other goods.
If some resources were withdrawn from producing
these low utility goods, total utility would fall very
little.

Q&A
Alesandro purchases two goods, X and Y, and the
utility gained for the last unit purchased of each is
16 utils and 23 utils, respectively. The prices of X
and Y are $1 and $1.75, respectively. Is Alesandro
in consumer equilibrium? Explain your answer.
The text cites a situation in which the buying
behavior of two rats followed the law of demand.
Does it follow that these two rats were attempting
to equate marginal utilities per push of the
lever? Explain your answer.

Behavioral Economics
Are People Willing to Reduce Others Incomes? In
a study, 62% of the participants made themselves
worse off in order to make someone else worse off.
Is $1 always $1? Sometimes people
compartmentalize their money.
Coffee Mugs and the Endowment Effect: We value
X more highly if we have it than if we do not have it
because such behavior at one point in our evolution
made possible a system of property rights in a world
where the alternative was the Hobbesian jungle.

Q&A
Brandons grandmother is very cautious about spending
money. Yesterday, she gave Brandon $100 for his birthday.
Brandon also received a gift of $100 from his father who
isnt nearly as cautious about spending money as Brandons
grandmother is. Brandon believes that it would somehow
be wrong to spend his grandmothers gift on frivolous
things, but that it wouldnt be wrong to spend his fathers
gift on such things. Why does Brandon feel this way?
What economic effect is this?
Explain the Endowment Effect.