|Choice and Indifference
|Marginal Utility vs. Price
- Rational behavior requires one to compare the anticipated
utility of each expenditure with its cost.
- To maximize utility, the consumer should choose that good
which delivers the most marginal utility per dollar.
- Economists assume the higher the satisfaction a good or
service provides, the more a consumer will pay.
- Utility - The pleasure or satisfaction
obtained from a good or service.
- There is an important distinction between total utility and
- Total Utility - The amount of satisfaction
obtained from entire consumption of a product.
- Marginal Utility – The change in total
utility obtained by consuming one additional (marginal) unit of a good
change in total utility
marginal utility =
change in quantity
- Law of Diminishing Marginal Utility – the
marginal utility of a good declines as more of it is consumed in
a given time period.
- The law of diminishing utility applies to short time
- As long as marginal utility is positive, total utility
must be increasing
- Consumers choose the optimal consumption - the mix of
purchases that maximizes the utility attainable from available income.
Utility Maximizing Rule ==> ----- = -----
- If a person could get more utility per dollar by buying
good X, then they
should continue to buy good X until the ratios are equal. Only
will utility be maximized.
- indifference curves depict the alternative
combinations of goods and services that yield equal satisfaction
- an indifference map is the set of
curves that depicts all possible levels of utility attainable from
combinations of goods and services
- we assume that all consumers strive to maximize their
- higher indifference curves are more expensive thus we are
faced with budget constraints
- the objective is to reach the highest indifference curve
given our budget constraint ==> optimal consumption
- the indifference curve that is tangent to
our budget constraint curve represents optimal consumption
- the slope of the budget constraint curve represents the relative
price for the 2 goods (also known as the rate of
- the slope of the indifference curve is called the marginal
rate of substitution
- rate of market exchange = marginal
rate of substation