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Consumption Theory. Why Growth and maintenance of life process Comfort Satisfaction – utility Pleasure – utility Display-Advertise status or perception of status Emulation. Utility Theory and Individual Choice. According to economists, our behavior is motivated by rational self interest.

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consumption theory
Consumption Theory
  • Why
    • Growth and maintenance of life process
    • Comfort
    • Satisfaction – utility
    • Pleasure – utility
    • Display-Advertise status or perception of status
    • Emulation
slide2

Utility Theory and Individual Choice

  • According to economists, our behavior is motivated by rational self interest.
  • According to this theory, two things determine what people do:
    • The pleasure people get from doing or consuming something
    • The price of doing or consuming that something.
utility and consumption
Utility and Consumption
  • Total Utility
  • Marginal Utility
    • Next unit
    • Change in total utility from next unit of consumption
  • Diminishing Marginal Utility
    • Time
    • More is less
slide4

Diminishing Marginal Utility

  • . The principle of diminishing marginal utility – after some point, the marginal utility received from each additional unit of a good decreases with each additional unit consumed.
    • As additional units are consumed, marginal utility decreases, but total utility continues to increase.
    • When total utility is at a maximum, marginal utility is zero.
    • Beyond this point, total utility decreases and marginal utility is negative
slide5

14

1

2

3

4

5

6

7

8

9

Marginal and Total Utility

Number of pizza slices

Total utility

Marginal utility

14

26

12

36

10

44

8

50

6

54

4

56

2

56

0

54

-2

slide6

70

60

Marginal and Total Utility

50

Total utility

40

30

20

10

Total utility

0

Q

Marginal utility

1

2

3

4

5

6

7

8

9

16

14

12

10

8

Marginal utility

6

4

2

0

Q

1

2

3

4

5

6

7

8

9

-2

slide7

Maximizing Utility

How to get the most for your Money

Maximizing Utility – relationship of utility to price

MU/P

  • MUa/Pa = MUb/Pb
  • And so on for all goods
  • Consume another unit of a if:
  • Consume another unit of b if:
a numerical example
A Numerical Example
  • MUa/Pa = MUb/Pb
  • MUa = 20
  • Pa = 10
  • MUb = 50
  • Pb = 50

MUa/Pa = 20/10 2

MUb/Pb = 50/50 1

2 > 1

So buy more of good a

slide9

A Numerical Example -- continued

But consuming more of a It’s marginal utility decreases

  • MUa/Pa = MUb/Pb
  • MUa = 10
  • Pa = 10
  • MUb = 50
  • Pb = 50

MUa/Pa = 10/10 1

MUb/Pb = 50/50 1

1 = 1

So = nirvana

consumer surplus

P

Consumer Surplus

Consumer Surplus

S

Pe

D

Qe

Q

Consumer Surplus
slide11

But then Reality Sets In

  • Getting MUa/Pa = MUb/Pb may be difficult to do
  • How do we know what MU is for each good we buy

Example – Alcohol

        • Beer
        • Wine
        • Liquor