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University of Balamand

Faculty of Business & Management


Survey of Economics

Utility:

 Utility = satisfaction: it refers to the extent to which goods and services are preferred
by a consumer.

 Assumptions:
- consumers are rational, their aim is to maximize utility.
- income/budget is limited.

 Unit of Measurement: Utils

Q Marginal
Total Utility
(Ice Cream) Utility

0 0
4

1 4
3

2 7
2

3 9
1

4 10
0

5 10
-1

6 9

 Total Utility schedule of an individual during a given time frame.

 Marginal: is the extra “something” resulting from one additional unit of “something
else”.

 Marginal Utility: the extra satisfaction a consumer derives from consuming one
additional unit of the good.

∆𝑇𝑈 ∆𝑌
 MU = = => MU is the slope of TU
∆𝑄 ∆𝑋
University of Balamand
Faculty of Business & Management
Survey of Economics

 TU and MU
 From Q=0 to Q=4
TU at a decreasing rate
MU + and 

 From Q=4 to Q=5


TU is maximum
MU is 0
Slope at maximum = 0

 From Q=5 to Q=6


TU
MU –

 MU3 => MU of the 3rd cone of ice cream = 2 utils

 TU3 => TU of 3 cones of ice cream


1st method: read from schedule: 9 utils
2nd method: TU at a certain point is the summation of all MUs up to that
point => TU3 = MU1 + MU2 + MU3 = 4+3+2 = 9 utils

TU
12

10

0 Q
0 1 2 3 4 5 6 7

4
MU
3

0
0 1 2 3 4 5 6
-1 Q
-2
University of Balamand
Faculty of Business & Management
Survey of Economics

 Total Utility Maximizing Rule = Consumer Equilibrium:


We need to know the condition under which the consumer is most satisfied with the
combination of goods purchased. The fundamental condition of maximum utility is:
A consumer with a fixed income faced with given market prices will achieve maximum
utility when the marginal utility of the last $ spent on each good is exactly the same
as the marginal utility of the last $ spent on any other good.

𝑀𝑈𝑎 𝑀𝑈𝑏 𝑀𝑈𝑐


= = =…
𝑃𝑎 𝑃𝑏 𝑃𝑐

We divide by P to have the same basis of comparison.

The last $ spent on (a) brings the same MU as the last $ spent on (b) …

MU per $ spent on (a) = MU per $ spent on (b) …

 Derivation of Demand:
A consumer is buying 2 goods: A and B
He is at his consumer equilibrium.

What happens if PA  ?

𝑀𝑈𝑎 𝑀𝑈𝑏
Initially: =
𝑃𝑎 𝑃𝑏

𝑀𝑈𝑎 𝑀𝑈𝑏
PA  => <
𝑃𝑎 𝑃𝑏

The consumer needs to restore equality in order to maximize utility.


𝑀𝑈𝑎 𝑀𝑈𝑏
 He should  𝑃𝑎 and  𝑃𝑏 , but prices are beyond the control of consumers,
they are determined in the market
 He should  MUA by consuming less A and  MUB by consuming more B,
according to the law of diminishing MU.
 PA  => QA  : Law of Demand

 Paradox of Value:
Why is that water, which is essential to life, so cheap and diamonds, which are not
needed to survive, so expensive? (Adam Smith)