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GCH 05
GCH 05
What is a Util?
A hypothetical unit used to measure how much utility a person obtains from consuming a good
TU and MU
Q 0 1 2 TU 0 10 18 10 8 MU
3
4
24
28
6
4
5
6 7
30
30 28
2
0
-2
What is the Law of Diminishing Marginal Utility? As more of a good is consumed, at some point, the marginal utility a person derives from each additional unit diminishes
Does the Law of Diminishing Marginal Utility apply to all goods consumed?
YES
1999 South-Western College Publishing
Total Utility
Quantity
8
8
TU
Marginal Utility
9 MU
9
Demand Curve
P1
P2 Q1
Q2
D
10
Why does
MU = P
explain the downward sloping demand curve?
If you are hungry for a hot dog, how many hot dogs will you buy?
Up to where your
MU = P
1999 South-Western College Publishing
Why?
Because if MU > P you will buy another hot dog If MU < P you will not buy that last hot dog
1999 South-Western College Publishing
At P1, consume to Q1, since MU > P up to that point, at P2, consume to Q2, etc.
P1
P2
MU
Q1 Q2
1999 South-Western College Publishing
14
Consumer equilibrium
Now go from 1 good to 2 or more goods: have to take prices of good into account
Why? 1
Purchase more of X (due to its greater satisfaction per dollar), and less of Y
But more of X reduces MUX and less of Y increases MUY so we are heading back to equilibrium!!
When the last dollar spent on each good yields the same marginal utility
1999 South-Western College Publishing
Applications of Utility
The water-diamond paradox--why is water so cheap and diamonds so expensive?
MU due to abundance, diamonds the oppositePrice reflects marginal valuation, not totals
What statement do these sites make about the marginal utility of diamonds?
http://www.rostar.com
http://www.usdiamond.com
The difference between the maximum amount that a consumer is willing to pay for something and what he actually pays
1999 South-Western College Publishing
Consumer Surplus
P
Q 2
29