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    Micro Ch06 TheUtilityApproach

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    Micro Ch06 TheUtilityApproach

    Uploaded by

    amyleemalan2406
    6 views26 pages
    Eco notes

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    Micro-Ch06-TheUtilityApproach

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    6 views26 pages

    Micro Ch06 TheUtilityApproach

    Uploaded by

    amyleemalan2406
    Eco notes

    Copyright:

    © All Rights Reserved
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    Download as pdf or txt
    of 26

    LECTURE OUTLINES

    Chapter 6:
    The theory of demand: the
    utility approach
    Slides integrated by Carmen Christian
    Outline
    • The theory of demand: a reminder

    • Utility

    • Marginal utility and total utility

    • Consumer equilibrium in the utility approach

    • Derivation of an individual demand curve for a


    product

    • Comment on the utility approach


    The theory of demand

    • NB: Theory always a simplification of reality

    • Therefore theory always abstract

    • When analysing consumer behaviour we make


    simplifying assumptions

    • This can frustrate you IF you confuse theory with


    description!
    Utility

    • Utility – the degree of satisfaction that a


    household or consumer derives or expects to
    derive from the consumption of a good or service

    • Purpose of consumer behaviour –


    maximisation of utility, given the available
    means and alternative consumption possibilities
    • Utility of a good is the degree to which it
    satisfies human wants

    • However, a particular good does not have a


    unique, measurable utility which applies to all
    consumers

    • Tastes and wants vary amongst consumers


    • Utility approach (Chapter 6)
    Cardinal utility – assumption: utility can be
    measured

    • Indifference approach (Chapter 7)


    Ordinal utility – assumption: bundles of goods
    and services can be ordered according to
    preference
    • Utility approach (Chapter 6)

    • Based on assumption that consumer can


    subjectively assign values (utils) to the
    amount of utility (satisfaction) that he/she
    obtains from the consumption of each
    successive unit of consumer good/service

    • Also assumes that it is possible to compare the


    utility of different consumer goods
    quantitatively

    • I.e. based on notion of cardinal utility


    Marginal utility and total utility
    Consider Table 6.1

    • Marginal utility – the extra or additional utility


    that a consumer derives from the consumption
    of one additional unit of a good

    • Total utility – the cumulative sum of all the


    marginal utilities

    • Disutility – negative utility


    Total utility

    • Total utility increases as long as marginal utility


    is positive.
    • Total utility reaches a maximum when marginal
    utility is zero i.e. When the consumer is satiated.
    • Total utility then decreases when marginal
    utility becomes negative i.e. when disutility sets
    in.
    • The law of diminishing marginal utility – the
    marginal utility of a good or service eventually
    declines as more of it is consumed during any
    given period

    • Also known as Gossen’s first law (1854)

    • Illustrated in table 6.1

    • Box 6.1 (Self-study)


    Let’s try a natural experiment

    • See the top of pg. 134: A test


    Consumer equilibrium
    in the utility approach
    • The aim – achieve the highest attainable level of
    total utility
    Table 6-2:
    EXAMPLE 1 Thabo Botha’s
    marginal utility
    and total utility
    from the
    consumption of
    apples during a
    specific period
    (Textbook page
    138)
    Consumer equilibrium
    in the utility approach
    • The aim – achieve the highest attainable level of
    total utility

    • For a given income and given set of prices of


    goods, a consumer will be in equilibrium if
    he/she obtains the maximum possible utility

    • The consumer is in a position to arrange his/her


    wants in order of importance (based on his/her
    tastes) according to a list known as the scale of
    preferences.
    Consumer equilibrium
    in the utility approach
    • The aim – achieve the highest attainable level of
    total utility
    EXAMPLE 1 Table 6-3:
    Winnie’s scale
    of preferences
    in respect of
    the weekly
    consumption of
    bread, meat
    and rice
    (Textbook page
    138)
    • Table 6-2 says nothing about what Winnie can afford.

    • What happens if Winnie had a budget of R12?

    • Winnie has to determine the total utility of all the possible


    combinations of bread, meat and rice that she can
    purchase with R12.

    • Table 6-3: Winnie’s possible combinations in respect of


    the weekly consumption of bread, meat and rice that can
    be bought with R12 ( pg. 138)

    • Which combination will Winnie prefer?


    EXAMPLE 2
    • An easier solution to determining which
    combination maximises Winnie’s utility, is to
    examine the weighted marginal utility.

    • Weighted marginal utility: marginal utility


    divided (weighted) by the price of the product

    • Reflect on table 6-2 again.


    • Law of equalising the weighted marginal
    utilities – the consumer’s subjective valuation of
    the relative importance of the two goods is the
    same as the objective valuation of the market,
    as reflected in the market price of the goods
    concerned
    In simpler terms:
    • When the weighted marginal utilities of different
    goods are equal, and
    • Winnie has just spent her available income
    • she derives the same utility from the last rand
    spent on each product
    • i.e. MUb/Pb = MUm/Pm = MUr/Pr
    • Also:
    • From MUb/Pb = MUm/Pm
    • We can obtain MUb/MUm = Pb/Pm
    • i.e. the ratio of the marginal utilities must be the
    same as the ratio between the market prices of
    the goods
    • i.e. the rate at which the consumer is
    subjectively willing to exchange the two goods
    must be the same as the rate at which the goods
    are exchanged in the market
    To recap - Winnie is in equilibrium when:
    • The weighted marginal utilities of different goods
    are equal
    • The combination of goods purchased are
    affordable

    • This means that the consumer will be in


    equilibrium (i.e. total utility will be maximised)
    when the weighted marginal utility of each good
    is the same.
    • Note that these combinations have to be
    affordable!
    Derivation of an individual
    demand curve for a product
    • Demand curve – shows the quantities
    demanded of a good or service at different
    prices
    EXAMPLE 1

    Table 6-4: Helen Meyer’s utility from chocolates and yoghurt (per week).
    Budget per week equals R10. (Textbook page 140)
    EXAMPLE 2

    Table 6-5 Helen Meyer’s utility from the weekly consumption of chocolates and
    yoghurt at a lower price of chocolates (Textbook page 141)
    Helen increases her utility by consuming a greater quantity of chocolates when
    the price of chocolates fall, cet par
    EXAMPLE 3

    Figure 6-1: Helen Meyer’s demand curve for chocolates (Textbook page 142)
    Comments on the utility
    approach

    • Key concept – marginal utility

    • Important to understand the concept ‘marginal’


    and how it relates to an average value and a
    total value (this is why box 6.1 is nb!)

    • Utility cannot be measured objectively, only


    subjectively
    To do list…
    To do list…

    • Read and summarise chapter 6 & 7


    (micro)

    • Homework: Box 6.1, pg.134-136

    26

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