The utility of a good or service is the satisfaction or pleasure one gets from consuming it. Glasses are of immense utility to a person who has poor vision, but of no use to a person with 20-20 vision. To achieve the goal of utility maximization, the consumer must be able to compare utility. satisfaction) of the various 'baskets' that he can buy with his income.
Utility can be measured in monetary units by the amount of money the consumer is willing to sacrifice for another unit of a commodity. If the marginal utility of money changes as income increases (or decreases), the measure of utility becomes like an elastic ruler, inappropriate for measurement. The law states that the marginal utility derived from the consumption of equal successive units of a product for a given period of time will decrease as the quantity consumed increases.
Even though marginal utility is decreasing, total utility is still increasing as long as marginal utility is. Under these conditions, the consumer is in equilibrium when the marginal utility of x is equated with his market.
Equilibrium of the consumer
Suppose that Della has an unlimited budget to spend on ice cream cones and bottles of smartwater. Under these
The following table shows Della's benefit from consuming ice cream cones and bottles of smartwater:.
Suppose that Della has $7 per week to spend on ice
As noted by Adam Smith, water is essential to life and has a low market price (often a zero price), while diamonds are not so essential but have a very high market price. The marginal utility of water is low while the marginal utility of diamond is high. An alternative and more advanced approach to deriving demand curves uses an approach called indifference curves.
All combinations or bundles of two goods can be purchased by a person according to a certain monetary income and prices for both goods. If any of the three variables - the two prices and the individual's income - the budget changes.
Changes in the Budget Constraint
A change in the price of good X or good Y will change the slope of the budget constraint. A change in income will change the position of the budget constraint while keeping the slope constant.
INDIFFERENCE CURVES
CONSTRUCTING AN INDIFFERENCE CURVE
The curve representing an indifference set and showing all sets of two goods that give equal total individual utility.
Characteristics of Indifference Curves
- Indifference curves are downward sloping (from left to right)
- Indifference curves are convex to the origin
- Indifference curves that are farther from the origin are preferable because they represent
- Indifference curves do not cross (intersect)
The individual is willing to give up 3 units of milk to obtain an additional unit of orange juice (and thus move to point B). At point B, where she has 5 units of milk, she is only willing to give up 2 units of milk to get an additional unit of orange juice (and thus move to point C). An important peripheral point about marginal utilities is that the absolute value of the indifference slope.
The amount of a good that an individual is willing to give up to obtain an additional unit of another good and maintain equal total utility. The individual is willing to give up 3 units of milk to get an additional unit of orange juice, keeping total utility constant (between points A and B). The marginal substitution rate is therefore 3 units of milk for 1 unit of orange juice in the area between points A and B.
Indifference curves that are further from the origin are preferred because they represent the origin and because they represent larger bundles of goods. If we compare A and B, we believe that the individual must be indifferent between them because they lie on the same indifference curve. But if an individual is indifferent between A and B and between A and C, then he must also be indifferent between B and C.
But C has more of both goods than B, and so the individual will not be indifferent between B and C; she will prefer C to B. We have: (i) the budget line and its slope = Px/Py. ii) Indifference curve and its slope = MUx/ MUy At this point, the consumer's equilibrium is established and. Necessary condition: Utility is maximized when the indifference curve is tangent to the budget constraint.
We can add the individual's utility map to the budget constraint to show the utility maximization process. The tangency rule is only necessary, but not sufficient, unless we assume that the MRS is. If the MRS is not decreasing, then we need to check the second-order terms to make sure we are at the maximum.
Therefore, if the SKK is assumed to be always decreasing, the tangency condition is a necessary and sufficient condition for a maximum. In some situations, individuals' preferences may be such that they can maximize utility by choosing to consume only one of the goods.
From Indifference Curves to a Demand Curve
Rationality People are fundamentally rational and will adjust their decisions and behavior to best achieve their goals. People are unreasonable and make many mistakes that reduce their chances of achieving their goals. Willpower People easily resist temptation People do not have enough willpower and often fall victim to temptation.
The study of situations in which people act in ways that are not economically rational. NMOCs are as real as monetary costs and must be considered when making decisions. It is not consistent to refuse the offer that he wanted to cook for you for Tk.
Once you pay money and can't get it back, ignore that money later. 250 to watch a movie (matinee show) in the afternoon at Star Cineplex of Boshundhara Mall, while your friend offered you to watch the night show, who would cover the expenses. People overvalue the utility of current choices—eating chocolate cake or smoking—and underestimate the utility that can be obtained in the future.
