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Economic Principles
Total utility and marginal utility Law of diminishing marginal utility Relationship between the law of demand and the marginal-utility-to-price ratio Consumer surplus Difficulties with interpersonal comparison of utility
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EXHIBIT 1 TOTAL UTILITY AND MARGINAL UTILITY DERIVED FROM CONSUMING T-BONE STEAKS (UTILS)
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Exhibit 1: Total Utility and Marginal Utility Derived From Consuming TBone Steaks (utils) If marginal utility is declining, but is still positive, total utility is:
Total utility increases as long as marginal utility is positive.
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Exhibit 1: Total Utility and Marginal Utility Derived From Consuming T-Bone Steaks (utils) If marginal utility is declining, but is still positive, total utility is:
In Exhibit 1, total utility reaches its maximum at five t-bone steaks. Consuming more than five steaks will reduce total utility.
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French Cuisine and Marginal Utility Many courses, each with small
portions of food (French cuisine), may generate more utility than one course with a large portion of food because:
One large portion will drive down marginal utility. Marginal utility is high for the whole meal.
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Exhibit 3: Marginal Utilities of Clothes and Amusement Goods (Utils) Based on the utility data in Exhibit 3, a rational consumer will select the best combination of clothes and amusement goods:
By sequentially picking units of clothing and amusement goods that generate the largest MU/P.
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If a unit of clothes and amusement goods both cost $10, and if you have $80 to spend, the rational consumer will spend her money:
MU/P is equal when three units of clothes and five units of amusement goods are purchased (MU/P = 1.4).
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Marginal-Utility-to-Price Ratio
Marginal-utility-to-price ratio
The ratio is calculated by dividing the marginal utility of a good by the price of the goodMU/P.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle
A persons total utility is maximized when the ratios of marginal utility to price for the last unit of each of the goods consumed are equal.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
MU/P measures marginal utility per dollar spent.
Total utility will be maximized (within the constraints of a limited budget) when each individual purchase generates the largest possible MU/P. 29
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
A rational and fully-informed consumer will always shift a dollar from a good whose MU/P is lower to one whose MU/P is higher, if such a shift is possible.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
The principle is based on consumer behavior. Consumers will always arrange their sequence of choices among goods starting with the highest MU/P and running down to exhaust an expenditure budget.
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Marginal-Utility-to-Price Ratio
The MU/P equalization principle:
The consumer choice process is in equilibrium when: There is no longer any incentive for the consumer to rearrange her purchases. The MU/P is equal for the last unit of each good or service consumed.
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Exhibit 5: Comparing MU/Ps After a 20 Percent Off Sale on Clothes The MU/P of clothes changes when there is a 20 percent off sale on clothes by:
MU/P for each unit of clothing rises when price is reduced by 20 percent. This will cause a rational consumer to consume more clothes.
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An additional reduction in the price of clothing will change all of the MU/Ps for clothing, and thus change a rational consumers consumption of clothing.
If the price of clothes falls again, from $8 to $5, the quantity of clothing demanded increases from four to six units.
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Exhibit 9: Consumer Surplus on the Horseback-Riding Market Kims consumer surplus from horseback riding is:
$(15 - 6) for the first ride. $(12 - 6) for the second ride. $(9 - 6) for the third ride.
Exhibit 9: Consumer Surplus on the Horseback-Riding Market Tonys consumer surplus from horseback riding is:
$(10 - 6) for the first ride.
$(8 - 6) for the second ride. $(6 - 6) for the fourth ride. These sum to $(4 + 2 + 0) = $6.
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Exhibit 9: Consumer Surplus on the Horseback-Riding Market Randys consumer surplus from horseback riding is:
$(9 - 6) for the first ride.
$(6 - 6) for the fourth ride. These sum to $(3 + 0) = $3.
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Exhibit 9: Consumer Surplus on the Horseback-Riding Market If Kim, Tony and Randy represent the entire market demand for horseback riding, the total consumer surplus is:
$18 (Kim) + $6 (Tony) + $3 (Randy) = $27 in consumer surplus
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