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K. Adjei-Mantey
Department of Economics
Marginal Utility Theory
Utility and Marginal Utility
•2
Every economic agent attempts to make the best out of every
decision
Marginal utility theory explains how consumers get the best
satisfaction possible given their preferences and their constraints.
Consumers striving to maximize their utility
Utility actual quantitative measure of well-being or satisfaction
Measured in utils
Anything that makes a consumer better off
Increases utility
Anything that makes a consumer worse off
Decreases utility
Total Utility and Marginal Utility
•3
Assume a consumer, Ama, who likes cone ice cream
Total Utility and Marginal Utility
•4
Total Utility is the total satisfaction an individual gains from
consuming all the quantities of a commodity.
Marginal utility is the change in utility that an individual
enjoys from consuming an additional unit of a good
The Law of Diminishing marginal utility
As consumption of a good or service increases, marginal utility
decreases
The marginal utility of a thing to anyone diminishes with every
increase in the amount of it s/he already has
Total Utility and Marginal Utility-
•5
Number of
cones
Total Utility
(Utils)
Marginal
Utility (Utils)
0 0 utils -
1 30 30
2 50 20
3 60 10
4 65 5
5 68 3
6 68 0
•Ama’s total utility
increases with each cones
consumed
•However additional utility
from each successive cone
decreases, as she
consumes more cones
Utility and Marginal Utility- Graphical Illustration
•6
Number of
cones
Total
Utility
Marginal
Utility
0 0 utils -
1 30 30
2 50 20
3 60 10
4 65 5
5 68 3
6 68 0 Ice cream cones per
week
Ice cream cones per
week
Utils
Utils
70
5 6 4 3 2 1
50
30
30
10
20
6 5 4 3 2 1
Marginal Utility
Total Utility
Given the ‘preferences’
assumptions of the Marginal
Utility theory, would Ama
ever consume more than 5
ice cream cones?
Combining the Budget constraint and
Preferences
•7
Marginal Utility
Tells us about a person’s preferences
Budget Constraint
Which combinations of goods s/he can afford
Combining both preferences and budget constraint can yield
an individual’s utility-maximising choice
Recall meaning of demand
Willingness + ability = demand
Illustration
•8
Go back to Kweku and his consumption of concerts and
movies
Same information about his budget constraint
Entertainment budget, prices of movies and concerts
Additional information about preferences
The Budget Constraint and Preferences
•9
Kweku Consumption Possibilities with Income of Ghc150 per month
Point on Budget line
Concerts at Ghc30 Movies at Ghc10
No. of concerts / month
MU from last concert (MU)
MU per Ghc spent on last concert (MU/P)
No. of Movies / month
MU from last movie (MU)
MU per Ghc spent on last movie (MU/P)
A 0 - - 15 50 5
B 1 1500 50 12 100 10
C 2 1200 40 9 150 15
D 3 600 20 6 200 20
E 4 450 15 3 350 35
F 5 360 12 0 - -
Budget Constraint and Preferences
•10
MU/P is marginal utility per Ghc spent by Kweku on
concerts or movies
Gain in utility for each Ghc Kweku spends on each good
MU/P also decreases with increases in consumption
Why?
Budget Constraint and Preferences
•11
Kweku’s aim is to find affordable combination of movies and
concerts that gives him highest possible utility
This is where the marginal utility per Ghc is the same for
both goods
i.e. (MU/P) movies = (MU/P) concerts
Why is this so?
The Budget Constraint and Preferences
•12
Kweku Consumption Possibilities with Income of Ghc150 per month
Point on Budget line
Concerts at Ghc30 Movies at Ghc10
No. of concerts / month
MU from last concert (MU)
MU per Ghc spent on last concert (MU/P)
No. of Movies / month
MU from last movie (MU)
MU per Ghc spent on last movie (MU/P)
A 0 - - 15 50 5
B 1 1500 50 12 100 10
C 2 1200 40 9 150 15
D 3 600 20 6 200 20
E 4 450 15 3 350 35
F 5 360 12 0 - -
The Budget Constraint and Preferences
•13
Kweku will continue to
shift consumption until he
is at point D. •15
•9
•12
•3
•6
•2 •1 •3 •4
•A
•5
•B
•D
•C
•E
•Concerts Per month
•Movie
s p
er
month
•F
•(MU/P)c= 40; (MU/P)m= 15
•(MU/P)c= 15; (MU/P)m= 35
•(MU/P)c= 20; (MU/P)m= 20
Budget Constraint and Preferences
•14
Generalization
For any two goods x and y, with prices Px and Py,
Whenever MUx/Px > MUy/Py,
A consumer is made better off by shifting spending away from y
and towards x
.....And vice-versa
Budget Constraint and Preferences
•15
Further Generalization
A utility-maximising consumer will choose a point on the
budget line where marginal utility per dollar is the same for
both goods
Marginal Utility (MU) versus Marginal Utility per Price (MU/P)
•16
Shouldn’t a consumer spend whenever marginal utility is greater? Suppose individual likes private jet rides and wrist watches.
MU for private jet ride is 2000utils; MU for a watch is 1000utils.
Should funds be diverted to private jets or wrist watches?
What if private jet costs Ghc200 but wrist watches cost Ghc20?
Is your answer the same?
Marginal Utility (MU) versus Marginal Utility per Price (MU/P)
•17
Shouldn’t a consumer spend whenever marginal utility is greater?
No! Why?
Private jet rides give twice as much additional satisfaction…
… but cost 10 times more than wrist watches
Give up 10 wrist watches for a single private jet ride
Additional utility from spending Ghc1 on watches is 50; only 10 from private
jets
Spend on wrist watches
Private Jet Wrist watch
MU 2000 1000
P 200 20
MU/P 10 50
What happens when things change?
•18
Changes in Income
Suppose Kweku’s income increases to Ghc300?
What do you think will happen to his budget line?
The Budget Constraint and Preferences
•19
Kweku Consumption Possibilities with Income of Ghc300 per month
Concerts at Ghc30 Movies at Ghc10
No. of concerts / month
MU from last concert (MU)
MU per Ghc spent on last concert (MU/P)
No. of Movies / month
MU from last movie (MU)
MU per Ghc spent on last movie (MU/P)
3 600 20 21 20 2
4 450 15 18 30 3
5 360 12 15 50 5
6 300 10 12 100 10
7 180 6 9 150 15
The Budget Constraint and Preferences
•20
D 6
•3
Movies
per
month
Concerts Per month •9
3 J
H
•6
12
27 K •At H, what type of a good is
concerts? Movies?
•At point J, what type of a
good is concerts? Movies?
•At K, what type of a good is
concerts? Movies?
The Budget Constraint and Preferences
•21
Change in income
A rise in income with no change in prices leads to a new
quantity demanded for each good.
Whether a particular good is normal (increase in quantity
demanded) or inferior (quantity demanded decreases) depends
on the individual’s preferences
What happens when Things Change?
•22
Change in Price
What happens to Kweku’s consumption when the price of a
concert decreases from Ghc30 to Ghc10
Assume income and price of movies remains constant
The Budget Constraint and Preferences
•23
Kweku Consumption Possibilities with Income of Ghc150 per month
Concerts at Ghc10 Movies at Ghc10
No. of concerts / month
MU from last concert (MU)
MU per Ghc spent on last concert (MU/P)
No. of Movies / month
MU from last movie (MU)
MU per Ghc spent on last movie (MU/P)
3 600 60 12 100 10
4 450 45 11 120 12
5 360 36 10 135 13.5
6 300 30 9 150 15
7 180 18 8 180 18
8 150 15 7 190 19
9 100 10 6 200 20
10 67.5 6.75 5 210 21
Deriving the Demand Curve
•24
What happens if price of concerts falls further to Ghc5?
Show diagram
Each time the price of concerts changes, so does quantity
demanded of concerts
•25
Deriving the demand Curve
6
10
8
7 10
10
3
7 3
30
5 10
•Concerts Per month
Concerts Per month
Movies
per
month
Price
per
Concert
15 30
Take- home assignment
•26
Draw a downward sloping demand curve for movies when its
price falls, using the marginal utility approach
Try identifying points on Kweku’s budget line that would
VIOLATE the law of demand
i.e. construct an upward-sloping demand curve when prices
change for concerts or movies
Discuss: The Paradox of Value
•27
Sometimes referred to as the “Diamond-water” paradox
Why do many essential products that we use have relatively
low prices?
On the other hand, luxury products like diamonds have very
high prices.
The Paradox of Value
•28
Goods like water are readily available
As consumers consume more and more of them, their
marginal utility falls
It is not total use of diamonds or water that matters
Use of each additional unit, rather
Since water so readily available, marginal utility from
additional unit is low
Diamonds are not as available and therefore, consumption is
low and additional unit worth more
People willing to pay higher price for it
Next Class
•29
Indifference Theory
Diminishing marginal rate of substitution
consumer equilibrium
price consumption curve
income consumption curve
Derivation of the consumer’s demand curve
