Micro Chapter 19- Presentation 1

Law of Diminishing Marginal Utility

• Added satisfaction declines as a consumer acquires additional units of a given product

• The more the consumer obtains the less they want more of it

• Ex- cars (excluding collectors)

Law of Diminishing Marginal Utility

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(3)MarginalUtility,Utils

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Total Utility

Marginal Utility

Units Consumed Per Meal

Units Consumed Per Meal

Marginal Returns Video

• Diminishing Marginal Returns Video• http://www.youtube.com/watch?v=CfioxJ4E_

h4&feature=player_embedded

Vending Machines

• Coke machine v. Newspaper machines• Newspapers are open to take as many as you

want but MU goes to almost zero- obsolete after a day

• Coke is buy one get one

Time Value of $$$

• The value of money in the future, once interest has been considered

• Ex- 2 options: A)You could have $10,000 now or B) $10,000 3 years from now. Which is better?

• Present Value for both = $10,000• Future Value A = 10,000 + interest • Future Value B = 10,000

Real World Example

• Original mortgage = $140,000 over 30 years at 6.375% interest (fixed rate)

• Payment:• Principal and interest= $875• PMI= $68• Homeowner’s insurance = $62• Taxes= 328.34• Total = 1333.34 • 1333.34 x 360 = $480,002.40

Real World Example

• Original mortgage = $140,000 over 30 years at 6.375% interest (fixed rate)

• Payment:• Principal and interest= $875• PMI= $68• Homeowner’s insurance = $62• Taxes= 328.34• Total = 1333.34 • 1333.34 x 360 = $480,002.40

Money Saved

• If I didn’t refinance…• Still owe 26 years (312 payments @ 1333.34=

$416,002.08)• By refinancing: $416,002.08 – 225,900 = • Savings of $190,102.08

Theory of Consumer Behavior

• The idea of diminishing marginal utility explains how consumers allocate their incomes among the many goods and services available for purchase

Assumptions of Consumer Choice

• 1. Rational Behavior- consumers are rational and try to use $$ to derive the greatest satisfaction

• 2. Preferences- each consumer has clear-cut preferences for certain goods/services and have a good idea of how much marginal utility they will get from additional units of a product

Assumptions of Consumer Choice Cont’d

• 3. Budget Constraints- at any point in time consumers have a fixed amount of money income

• 4. Prices- goods are scarce relative to the demand for them, so every good carries a price tag

-people cannot buy everything they want

Utility Maximization Rule

• the last dollar spent on each product yields the same amount of marginal (extra) utility

• ***the consumer is in equilibrium and would be worse off (less total utility) if they altered purchases

Marginal Utility Per Dollar

• Used to make purchasing decisions• (Marginal Utility/Price) = MU/price• Choices are influenced by the MU that extra

units of product A will yield but also by how many $$ (and how many units of alternative product B) must be given up to obtain added units of A

Utility Maximization Rule

• MU of product A/Price of A = MU of B/Price B• If this equation is not true, then the consumer

should reallocate their funds differently

Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

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Compare Marginal UtilitiesThen Compare Per Dollar - MU/PriceChoose the HighestCheck Budget - Proceed to Next Item

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

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Again, Compare Per Dollar - MU/PriceChoose the HighestBuy One of Each – Budget Has $5 LeftProceed to Next Item

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

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Again, Compare Per Dollar - MU/PriceBuy One More B – Budget Has $3 LeftProceed to Next Item

`

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

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Again, Compare Per Dollar - MU/PriceBuy One of Each – Budget Exhausted

Do the Math

• All $10 have been exhausted and the last dollar spent provides the same marginal utility (8 utils)

• 2 units of A ($2) + 4 units of B ($8) = $10• 2 units of A = 18 utils + 4 units of B (78 utils)• 96 utils