This process of decision making described previously suggests a rule to follow when maximizing utility. Instead, we need to control for the prices of each product. We can do this by computing and comparing marginal utility per dollar of expenditure for each product.
If a consumer wants to maximize total utility, for every dollar that they spend, they should spend it on the item which yields the greatest marginal utility per dollar of expenditure. Table 1 shows that the marginal utility per dollar spent on the first T-shirt is 1. That combination, six movies and one T-shirt, is his consumer equilibrium.
Since the price of T-shirts is twice as high as the price of movies, to maximize utility the last T-shirt chosen needs to provide exactly twice the marginal utility MU of the last movie.
At this choice, the marginal utility per dollar is the same for both goods. This argument can be written as another rule: the utility-maximizing choice between consumption goods occurs where the marginal utility per dollar is the same for both goods, and the consumer has exhausted his or her budget.
A sensible economizer will pay twice as much for something only if, in the marginal comparison, the item confers twice as much utility. Notice that the formula for the table above is. The following feature provides step-by-step guidance for this concept of utility-maximizing choices. If we traded a dollar more of movies for a dollar more of T-shirts, the marginal utility gained from T-shirts would exactly offset the marginal utility lost from fewer movies. In other words, the net gain would be zero.
The best we can do is trade two movies for another T-shirt, since in this example T-shirts cost twice what a movie does. If we trade two movies for one T-shirt, we would end up at point R two T-shirts and four movies. Choice 4 in Table 3 shows that if we move to point S, we would lose 21 utils from one less T-shirt, but gain 23 utils from two more movies, so we would end up with more total utility at point S.
There is another, equivalent way to think about this. The rule can also be expressed as the ratio of the prices of the two goods should be equal to the ratio of the marginal utilities. When the price of good 1 is divided by the price of good 2, at the utility-maximizing point this will equal the marginal utility of good 1 divided by the marginal utility of good 2.
This rule can be written in algebraic form:. Consumers must choose among alternative goods with their limited money incomes. The Utility Maximization rule states: consumers decide to allocate their money incomes so that the last dollar spent on each product purchased yields the same amount of extra marginal utility. I t is marginal utility per dollar spent that is equalized. As long as one good provides more utility per dollar than another, the consumer will buy more of that good; as more of that product is bought, its MU diminishes until the amount of MU per dollar just equals that of the other products.
Consumer theory and demand theory suggest that consumer actions are driven toward utility maximization by attempting to acquire the most satisfaction possible in the most affordable way.
In general, classical economic theories show that most consumers want to get the highest possible level of utility per unit for the money they spend. Total utility is usually measured in relative units called utils. When measuring total utility, analysis can span from one unit of consumption to multiple units. For example, a cookie provides a level of utility as determined by its singular consumption, while a bag of cookies may provide total utility over the course of time it takes to completely consume all the cookies in the bag.
To better understand total utility, one must understand the Law of Diminishing Marginal Utility , which states that as more of a single good or service is consumed, the additional satisfaction, referred to as marginal utility, drops. The first good consumed provides the highest utility, the second good has a lower marginal utility, and so on. Therefore, total utility grows less rapidly with each additional unit consumed of the same good or service.
Each individual unit of a good or service has its own utility and each additional unit of consumption will have its own marginal utility. The total utility will be the aggregated sum of utility gained from all units being studied. A total utility formula will include utils. Utils are typically relative and assigned a base value. Economists usually analyze utils across a spectrum to provide a comparative analysis of the amount of util or satisfaction gained from a unit of consumption.
An assigned base value for utils is needed because theoretically there is no real value for utility satisfaction in general. To find total utility economists use the following basic total utility formula:. The total utility is equal to the sum of utils gained from each unit of consumption.
In the equation, each unit of consumption is expected to have slightly less utility as more units are consumed. Economic theory regarding consumer activities suggests that the primary goal of the consumer is to achieve the largest amount of utility for the least amount of cost. This is partly due to the limited amount of funds a person may possess, as well as a desire to achieve as much satisfaction from the consumption of goods and services as possible. For example, if a consumer is presented with two purchasing options with the same financial cost, and neither option is more necessary or functional than the other, the consumer will choose the good or service that provides the most utility for the money.
John is hungry and decides to eat a chocolate bar. His total utility from eating one chocolate bar is 20 utils. He is still hungry so he eats another chocolate bar, where his total utility is 25 utils. John is still hungry and has two more chocolate bars. The third chocolate bar has a total utility of 27 utils, and the fourth has a total utility of 24 utils. This is best represented in the table below.
With each additional chocolate bar, John's total utility increases, until it reaches its max at three chocolate bars. With the fourth chocolate bar, John's total utility decreases. This can be understood with marginal utility; the utility that John derives from each additional chocolate bar. With every additional chocolate bar after the first, John's marginal utility is decreasing, meaning that he is deriving less satisfaction from another chocolate bar.
This makes sense as he is getting more full with each bar. After the third bar, his marginal utility is negative, meaning he is deriving no satisfaction and in fact is made worse off; perhaps feeling sick after consuming so much chocolate and sugar. Total utility is the aggregate satisfaction that an individual receives from consuming a specific quantity of a good or service.
While total utility measures the aggregate satisfaction an individual receives from the consumption of a specific quantity of a good or service, marginal utility is the satisfaction an individual receives from consuming one additional unit of a good or service. If marginal utility is positive then total utility will increase. Once marginal utility is negative, then total utility will decrease. The basic formula to calculate total utility is as follows:. Marginal utility is calculated as follows:.
Total utility does not always increase.
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