Chapter 5: Utility

1
Chapter 5 Utility

• Its about being happy by eating what you want
  the most.

2
Overview

• UTILITY--maximizing satisfaction
• Consumer vs. producer surplus
• LAW OF DIMINISHING MU
• CONSUMER EQUILIBRIUM

3
I need a volunteer

• Good call
• You will now be given 10 to buy stuff in my
  store
• For each thing you buy you must tell us the
  utility (satisfaction) you gain from eating it
• Must eat it right now

4
Dirks Candy Land

• Mini-candy bar 1.00
• Grapes .50/5 grapes
• Can of Tuna 1.00
• Cheerios 1.00/handful
• What do you want to buy?

5
You are all different

• If you were doing the same thing, would have you
  made the exact same choices?
• Absolutely not!!!
• We all have different preferences, which means
  utility can and does change between people

6
Still Follow the Same Rules

• In any case UTILITY is viewed as being the
  SATISFACTION or VALUE you get from doing
  something
• As in the video, as long as that SATISFACTION is
  greater than the cost of the choice then it makes
  sense for you to do it.

7
Its about the next choice

• As we demonstrated with the food, our
  satisfaction constantly changes
• One decision might yield a higher satisfaction
  one day than it does the next
• As a rule you always consider your NEXT or
  MARGINAL decision over anything in the past

8
Less and less

• As with the berries we see that as we consume
  more and more of something, the value begins to
  decrease
• Hence the LAW OF DIMINISHING MARGINAL UTILITY
• 3rd reason for downward sloping demandmore and
  more of something becomes worth less and less to
  you

9
Always the max

• When you base your decisions on MU, the next
  thing you buy should always yield the highest
  MU/
• If the tuna and candy bar cost the same amount,
  why buy the candy bar over the tuna?
• It produces a higher value per dollar

10
CONSUMER EQUILIBRIUM

• As a rule then you always allocate your next
  purchase to the thing that gives the most MU/
• When that means buying something else you buy
  something else
• Eventually you would keep buying all types of
  things until the MU MB
• You never buy something when it is worth less to
  you (MU) than the price (MC)

11
The stead-fast rule

• As a rule (muy importante), CONSUMER EQUILIBRIUM
  is reached when the
• MU1/P1 MU2/P2 MU3/P3

12
Irony comes from water

• So we always buy what yields the most MU/
• Does that establish the importance of the items
  we buy?
• Adam Smith comes back with the PARADOX OF VALUE

13
DIAMONDS VS WATER

• Why do diamonds cost more than water?
• You die without water, diamonds offer very little
• ITS ABOUT MARGINAL UTILITY, not total utility
  (TU)

14
Never have a drink

• The total utility of water is life itselfyou
  cannot live without it
• But you also have/drink a lot of it
• The extra value from one more glass then is small
  while you dont have many diamonds
• The extra value from your first diamond, or even
  12th, will still be very high compared to that
  next drink
• Thats why we use MU/P

15
Buy what helps the most

• Yes, a new car gives more value than a pair of
  shoes, but you dont base your decision on TU
• You want to maximize your own value / dollar
  spent
• Looking to maximize your CONSUMER SURPLUS

16
This candy bar costs .10

• Lets have an auction using real money
• Who wants to buy this? How much would you pay?
• If you received that much value, but only paid
  .10 you have CONSUMER SURPLUS--additional gain
  over price paid

17
That drink after a long run

• The first bite of food after you havent eaten in
  days is absolutely incredible
• A coffee and newspaper Saturday morning
• Worth much much more than I pay for themI have
  received CONSUMER SURPLUS

18
Easier to look at than think about
19
If its about the MARGIN

• Is it a good idea, or worth the effort, to
  completely abolish pollution?
• Is it worth the cost for the additional gain?
• We want to say yes, but really its no
• It is easy to clean up at first, but eventually
  the MU lt MC and you dont receive any benefit for
  doing so
• Came from conference by real Environmental
  Economists

20
Same Goal All the Time

• In the end we always have the exact same
  goalmaximize MU per spent
• We know the LAW OF DIMINISHING MU (more we have
  the less its worth)
• This thought process guides us as consumers, but
  the same idea also drives the business world