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Full download Economics 12th Edition Michael Parkin Solutions Manual all chapter 2024 pdf
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C h a p t e r
8 UTILITY AND
DEMAND
Lecture Notes
Utility and Demand
• Economists assume that people behave to make themselves as well off as possible.
• Consumption possibilities tell us what the consumer can afford to buy given a limited income and the
prices of the goods and services they are considering.
• Preferences are reflected in the discussion of utility maximization
I. Consumption Choices
• Consumption possibilities are all the things a consumer can afford to buy.
The Budget Line
• The limits of consumption possibilities are illustrated with
a budget line.
• The budget line marks the boundary between those
combinations of goods and services that the consumer
can afford to buy and those that it cannot afford.
• The budget line shown illustrates the possible
combinations of pizza and books that a consumer with
$50 income could purchase if the price of pizzas were
$10 and the price of books were $10.
• The budget line constrains choices: Points on the budget
line and inside the budget line are affordable and within
the consumer’s consumption possibilities. Points beyond
the budget line are not affordable.
Where do the utility numbers come from? Year after year, you will get this question from the curious student.
While the numbers for utility are ordinal rather than cardinal, using those terms to explain utility to
undergraduates will generally result only in many blank stares. To help with one answer to this question, try the
following story: Lisa likes movies and books. We tell Lisa that we’re going to call the utility she gets from 1 movie a
month 24 units of utility. Then we ask her to tell us, using the same scale, how much she would like 2, 3, or more
movies, and 1, 2, 3, or more books.
Marginal Utility
• Marginal utility is the change in total utility that results Quantity of Total Marginal
from a one-unit increase in the quantity of a good movies utility utility
consumed. The table shows the marginal utility from 0 0
movies. 24
• When a good generates value, it has a positive marginal 1 24
utility. Total utility increases as the quantity consumed 20
increases. 2 44
18
Diminishing Marginal Utility
3 72
• Diminishing marginal utility is the principle that as
8
more of a good or service is consumed, its marginal utility
4 80
decreases. In the table the marginal utility diminishes as
more movies are consumed.
Consumer Equilibrium
• Consumer equilibrium occurs when a situation in which a consumer has allocated all available income in a
way that maximizes utility given the prices of the products.
A Spreadsheet Solution
• The most direct way to find the quantity of goods Quantity of Total Quantity Total
and services is to make a table with the choices movies utility of books utility
available. Suppose the price of a movie is $8, the 0 0 0 0
price of a book is $4, and the consumer has income 1 24 1 20
of $24.
2 44 2 30
• Calculate the combinations of products that 3 72 3 38
exhaust the available income given the prices of
4 80 4 44
the goods. In the table, the consumer can
5 84 5 48
afford (3 movies/0 books), (2 movies/2 books),
6 86 6 50
(1 movie/4 books), and (0 movies/6 books).
While the consumer can also afford the combinations of products inside the budget line, the smaller
quantities associated with those points would have less utility than the points on the budget line.
• From the utility figures given for each product, calculate the total utility from the combination of the
two products. In the same order as the affordable combinations above, these total utilities are 72, 74,
68, and 50. Emphasize that it is total utility from the combination of the two products that the
consumer is trying to maximize.
• Select the combination that gives the maximum total utility, (2 movies/2books for total utility of 74)
in this case.
• While in a model we might calculate the total utility from all the possible combinations of products and
then select the combination with the highest utility, this is not a likely approach for consumers in practice.
• A more natural way to find the consumer equilibrium is to use marginal analysis to make the decision.
Do people really calculate and compare marginal utilities and prices? One of the challenges in teaching the
marginal utility theory is getting the students to appreciate the fundamental role of a model of choice. The goal is
to predict choices, not to describe the thought processes that make them. Gary Becker has made the following
point, updating the reference to the pitcher (from Parkin, Economics, first edition, 1990, p. 154): Justin Verlander
(or substitute a currently hot pitcher) unanimously won the 2011 Cy Young award for the American League. He
effectively knows all the laws of motion, of hand-eye coordination, about the speed of the bat and ball, and so on.
He’s in fact solving a complicated physics problem when he steps up to pitch, but obviously he doesn’t have to
know physics to do that. Likewise, when people solve economic problems rationally they’re really not thinking,
“Well, I have this budget and I read this textbook and I look at my marginal utilities and the prices and determine
what maximizes my utility.” People don’t do that, but it doesn’t mean they’re not being rational. Just because a Cy
Young Award winner isn’t Albert Einstein doesn’t mean he can’t make rational decisions about pitching.
• The rule to spend all income and equalize marginal utility per dollar from each good maximizes utility
because anytime the marginal utility per dollar from one good exceeds that of another good, the
consumer can increase his or her total utility by spending a dollar less on the good with the lower
marginal utility per dollar and spending the dollar on the good with the higher marginal utility per dollar.
Counterexamples can help. To help the students see that maximizing total utility requires equalizing the marginal
utility per dollar on each good, work with the case when they are not equal. Suppose the marginal utility per dollar
from a movie is 20 and the marginal utility per dollar from a soda is 10. Ask “If you gained an additional dollar,
what would you spend it on and by how much would your total utility increase?” The students will spend it on
movies and their total utility will rise by 20. Now ask the students “If you lost a dollar, what you cut back on and
how much would your total utility decrease?” The students will cut back on sodas and their total utility will fall by
10. Now tell the students that they can gain a dollar by cutting back a dollar on sodas. Ask them the net change in
their total utility, which is +10. The point to make is that anytime the marginal utility per dollar from one good
differs from that for another good, consumption can be rearranged by cutting back on the good with the low
marginal utility per dollar and spending the dollar on the good with the high marginal utility per dollar and
increasing total utility.
Why don’t consumers simply choose the goods with the highest marginal utility? Students will find it
relatively easy to simply memorize the rule that maximizing utility requires that the marginal utility per dollar is
equal across all goods, but, intuitively, students still often expect marginal utility to be the only determinant of
utility maximization. To provide some additional intuition, ask them to think about two goods they’re trying to
choose between, like a new shirt and a new download of a song. Say a new shirt would have a marginal utility of
20, while the download would have a marginal utility of 1. The price of a new shirt is $30, while the price of the
download is $1. Should you purchase the new shirt because it has a higher marginal utility? No! You may prefer
the shirt, but it costs thirty times as much as the download. Even though the download has the lower marginal
utility, it has a higher marginal utility per dollar (1 as opposed to 2/3).
Other applications of marginal reasoning. Help your students to appreciate that marginal reasoning is one of
the most important tools for understanding the economic perspective. Remind them that we have been using
marginal reasoning for many chapters now: In Chapter 2 we derived the marginal cost of production from the PPF.
In Chapter 5 we discovered that competitive equilibrium is efficient because marginal social benefit (from the
demand curve) equals the marginal social cost (from the supply curve). In this chapter, we discover that equating
the marginal utility per dollar across all goods and services maximizes a consumer’s utility. More generally, marginal
analysis shows that if the marginal gain from an action exceeds the marginal loss, take the action.
Revealing Preference
• We don’t have to ask a consumer to state preferences because we can figure them out by observing what
is purchased at various prices.
• The units we use to measure preference don’t matter. Any arbitrary unit will work; for instance, if utility
is multiplied by 2, the marginal utility per dollar equation shows that the equilibrium consumption bundle
does not change.
• The resolution to this paradox comes from distinguishing total utility from marginal utility. The total utility
from water is much more than from diamonds. But we have so much water that its marginal utility is
small. And we have so few diamonds that their marginal utility is high. When a household maximizes its
utility, it makes the marginal utility per dollar equal for all goods. Because diamonds have a high marginal
utility, they have a high price. Because water has a low marginal utility, it has a low price.
• Consumer surplus also can be used to resolve the paradox as well. The consumer surplus from
consuming water is vast but the consumer surplus from consuming diamonds is small.
Temperature as an Analogy
• Temperature and utility are both abstract concepts.
• The concept of utility allows economists to make predictions about human choices just as temperature
allows predictions of physical phenomena.
• Utility may not be as precise a thermometer in making some types of predictions but is still useful.
An Economics in Action case considers the utility from recorded music and concludes that the availability and
convenience of downloading individual songs increases consumer surplus. The utility from playing an album is
greater using a CD, so most albums are played on CDs.
Endowment effect in the housing market: The housing market entered a severe slump in the late 2000s and
took years to even begin to emerge. One factor might have been the endowment effect: The price that home
buyers were willing to pay for a house is lower than what homeowners, with the endowment effect, believe their
home is worth. Consequently homes might sit on the market for long periods of time.
Neuroeconomics
• Neuroeconomics is the study of the activity of the human brain when a person makes an economic
decision. Different decisions appear to activate different areas of the brain. Some decisions are made in
the pre-frontal cortex, which is where memories are stored and data are analyzed. These decisions might
be deemed rational. Other decisions are made in the hippocampus, which is where memories of anxiety
and fear are stored. These decisions might be deemed irrational.
Controversy
• Whether economics should focus on explaining the decisions we observe or on what goes on inside
people’s heads is the source of controversy.
The Reading Between the Lines case at the end of the chapter about efforts to outlaw large, sugary drinks should
draw student reaction and interest about the role of government in helping citizens make better decisions.
Although the students have not yet learned about externalities, part of the discussion can include whether
government can protect itself as a payer of health care costs for the poor and elderly.
Additional Problems
1. Mary enjoys classical CDs and travel
Quantity Total utility from Total utility from
books and spends $50 a month on them.
per month classical CDs travel books
The table shows the utility she gets from
each good. 1 30 30
2 40 38
a. Compare the two utility schedules.
3 48 44
Can you say anything about Mary’s
4 54 46
preferences?
5 58 47
b. What do the two utility schedules tell
you about Mary’s preferences?
c. If a classical CD and a travel book cost $10 each, how does Mary spend the $50 a month?
2. Rob enjoys rock concerts and the opera.
The table shows the marginal utility he Concerts Marginal utility Marginal utility
gets from each activity. Rob has $100 a per month from rock from operas
month to spend on concerts. A rock concerts
concert ticket is $20, and an opera 1 90 120
ticket is $10. How many rock concerts 2 80 90
and how many operas does he attend? 3 60 60
4 40 30
3. In problem 2, Rob’s uncle gives him $30 5 20 20
to spend on concert tickets, so he now
has $130. How many rock concerts and how many operas does he attend now that he has $130
to spend?
4. In problem 2, if the price of a rock concert decreases to $10, how many rock concerts and
operas will Rob attend?
2. If the Surgeon General (and the American Medical Association) concludes that moderate
wine and beer consumption can have a positive influence on cardiovascular health, how
will utility and demand be affected? Ask the students to use utility theory to explain how
changes in the marginal utility of beer and wine consumption will cause the demand for beer and
wine to increase, despite unchanged short-run prices or consumer incomes.
3. Would people voluntarily pay for something seemingly undesirable? Get students to see that
the utility they get from one good is oftentimes dependent on the level of other goods and
services consumed. Ask the students to use utility theory to explain:
1) Why do people regularly put themselves through undesirable, rigorous exercise programs?
(better health increases our marginal utility of engaging in other activities)
2) Why do students forgo lots of leisure time to take college classes? (better education increases
our appreciation of the world and allows us make better choices in our lives)
Help the students see that consumers invest in apparently undesirable goods the same way society
invests in capital to increase future consumption—except it is human capital that consumers are
investing in.
4. How could utility theory help us understand the difference between a federal income tax
and a federal sales tax on consumer consumption patterns? This is a real-world application of
utility theory designed to boost student confidence.
• Mention that federal sales tax proponents point out that sales taxes do not penalize savings
whereas income taxes penalize both savings and consumption, motivating consumers to save
less and consume more.
• Recall how Chapter 2 used the production possibilities frontier model to show that higher
present consumption and lower present investment (which is largely based on savings)
decreases future consumption for society through slower economic growth.
• Explain how consumers allocate their income across affordable consumption and savings
combinations by equating the ratio of marginal utility per dollar for both. If the same tax
revenue was collected by a federal sales tax rather than the income tax, the tax price for
savings would decrease and the tax price for consumption would increase. (Make sure you
explain that “savings” is an example of a “good.” In the examples used in the text, there is no
savings. All income is spent on goods. When savings exists, not all of a consumer’s income is
spent, but all of the income is allocated to either consumption goods or savings.)
• Show how consumers adjust these ratios by increasing the marginal utility of consumption
through less consumption and decreasing the marginal utility of savings by saving more. Utility
is maximized at a higher level of savings when consumption is penalized through a
consumption tax instead of an income tax.
5. How does utility theory differentiate a “need” from a “want”? If you are really in the mood
for a very heated discussion on utility analysis, just ask the students what the marginal utility
function for a “necessity” looks like. The students should recognize that it is perfectly vertical,
where no increase in price is sufficiently large to cause the person to decrease consumption of a
necessity in order to equate the marginal utility per dollar ratios across all goods and services. All
income is spent on necessity until the consumer is sated, and remaining income is allocated across
goods and services until the marginal utility per dollar ratios equalize. (This type of a utility
function reflects lexicographic preference orderings.)
Is a vertical utility function a reasonable outcome to expect for any good, even medicine or
food? Point out that even the poorest of people allocate their meager incomes across more than
just one good or service (the necessities). Somehow the income is allocated despite the supposed
vertical marginal utility curve.
How is income allocated across multiple “necessities” if all have vertical marginal utility
functions? Point out that if there is more than one “necessity,” then there is more than one
marginal utility function involved in allocating income. Help students to recognize that because in
the real world the poor allocate their income across multiple goods, then the marginal utility per
dollar ratios involved cannot be vertical, but they may be very steep. Emphasize that for these
consumers to maximize their utilities, each of the marginal utility per dollar ratios will need to be
equalized, making the income allocation process indistinguishable from mere “wants.”
Is it even meaningful to differentiate needs from wants among multiple goods or services?
There is no positive answer to this question—only a normative one. Utility analysis has just
proven that there is no positive definition of a necessity. Now step back and let the sparks fly!
6. It is often difficult to create incentives for behavior that is very good for us in the long run
but not necessarily pleasurable in the short run (studying, eating right, and exercising) and
disincentives for activities that lead to future pain but present pleasure (smoking, eating
whatever is convenient and tasty, sleeping through class). Have students suggest possible
incentives/disincentives that they think might address this problem. Attendance and being
prepared for class, eating right and moving more, and all kinds of other things promote our long
run best interests but we live in world where diabetes is a growth industry and where many
students think that access to notes in classroom technology packages means they don’t need to
attend or read the book. What do they think would work, both personally and at the level of
social policy? How does this relate to marginal utility theory?
7. Type 2 Diabetes is often related to poor diets and lack of exercise. If it is avoidable, how
does the material in this chapter help us understand why it is on the rise around the world?
The answer to this question might well be related to bounded rationality. It definitely ties in well
with a discussion of the Reading Between the Lines case.
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