CHAPTER 8: UTILITY AND DEMAND

 Consumption Choices
The choices that we as buyers make. This can be summarized under two broad headings:

1) Consumption Possibilities
Are all the things that we can afford to buy, as we can be limited by our income and the prices that
we pay. Th easiest way to describe consumption possibilities is when we consider a model consumer
who only buys two things.

 CONSUMERS BUDGET LINE:

We can describe the limit in which we spend all our income by a budget line which is the line
that marks the boundary between what is affordable and unaffordable.

 CHANGES IN CONSUMPTION POSSIBILITES

Consumption possibilities change when there is a change in price or income.
A rise in income shifts the budget line outward but leaves the slope unchanged.
A change in price changes the slop of the line.

2) Preferences
The choice of what we buy depends on preferences – what is like/dislike. One approach to describe
preferences deeper than the marginal/demand curve is Utility as the benefit of the satisfaction that a
person gets from the consumption of a goods and services. We can distinguish two utility concepts:

 TOTAL UTILITY
The total consumption that a consumer receives from all of the goods and services. Total
utility depends on the level of consumption – more consumption generally gives more utility.
Example: We can get any scale to measure Lerato’s total utility and we can give her two
starting points.
1.) We call the total utility form no chocolate and no cooldrink zero utility.
2.) We call the total utility she gets from eating 1 chocolate bar a month 50 units.
After asking Lerato we get the following results.
  MARGINAL UTILITY
The change in total utility that results from one-unit increase in the quantity of a good
consumed. Marginal utility if positive but it diminishes as the quantity of the good,
consumed increases.

The tendency for Marginal Utility to decrease as the consumption of a good increases is so
general and universal that we give it the status of principle – Diminishing Marginal Utility

 Utility Maximising Choices

Consumers want to get the most utility possible from their limited resources.

 A spreadsheet solution
The most direct way of finding the quantities of chocolate and cooldrink that maximise her
utility is to make a table in a spreadsheet with the information and calculations shown in the
table:

Find the just-affordable combinations: We noted that the budget line shows that Lerato can
also afford any combination inside the budget line. The quantities in those combinations
would be smaller than the ones shown in Table 8.2, and they do not exhaust her R40. But
 smaller quantities do not maximise her utility. Why? e marginal utilities of chocolate bars and
cooldrink are positive, so the more of each that Lerato buys, the more total utility she gets.

Find the total utility for each just-affordable combination: In Row C, Lerato maximizes his
utility 315(biggest number) by purchasing 2 bars and 6 cans of cooldrinks.

Consumer Equilibrium: This describes Consumer Equilibrium which is a situation in which a

consumer allocated all his/her available income in the way that maximizes his/her total
utility, given the prices of goods and services. (2 bars and 6 cans=CE)

 A Marginal Utility per Rand

Marginal Utility is the increase in total utility that results from consuming one more unit of a
good.

Marginal Utility is the increase in total utility that results from consuming one more unit of a
good.
 UTILITY MAXIMISING RULE
A consumer’s total utility if maximised by the following rule:
1. Spend all available income – Because more consumption brings more utility,
only those choices that exhaust income can maximize utility.
2. Equalize the marginal utility per rand for all goods – The basic idea behind
this good is to move the rands from Good A to good B if by doing so
increases the utility from Good A by more than it decreases utility form
Good B
 THE POWER OF MARGINAL ANALYSIS
The method above is called the Power of Marginal Analysis where Lerato maximizes
utility by comparing the marginal gain from having more of one good with the
marginal loss from less of another good. The Rule is simple:
If Marginal Utility per rand from chocolate exceeds the marginal utility per rand from
cooldrink, eat more chocolate buy less cooldrink.
If the marginal utility per rand from cooldrink exceeds the marginal utility per rand
from the chocolate, buy more cooldrink and eat fewer chocolate bars.