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Utility

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									Questions with the same answer

• Why do NBA owners want NBA players to take a
    pay cut?
•   Why do rich people want lower taxes?
•   Why does Mitt Romney want to be President?
•   Why does Barack Obama want to stay
    President?
•   Why are you attending SUU?
Consumer Theory:
Summarized
• People buy what they want with
  what they have.
• People make decisions according to
  the dictates of cost-benefit analysis
  where the cost of buying a product is
  its price and the benefit is the utility
  a person derives from the products
  consumption.
Utility
• Utility - a measure of the satisfaction
    (happiness, benefit) that results from the
    consumption of a good.
•   Total Utility- The total satisfaction a
    person receives from consuming a
    product.
•   Marginal Utility- The utility a person
    receives from consuming an additional
    unit of a good.
Gossen’s First Law
• Hermann Gossen (1810-1858)
• http://homepage.newschool.edu/~het/p
    rofiles/gossen.htm
• Development of the Laws of Human
    Relationships, 1854
• Gossen’s First Law: The principle of
    diminishing marginal utility.
•   The Law of Diminishing Marginal Utility -
    The marginal utility gained by consuming
    equal successive units of a good will
    decline as the amount consumed
    increases.
Gossen’s Second Law

• Consumers will maximize their total
 utility by purchasing so that the last
 unit of money spend for any one
 good gives the same marginal utility
 as the last unit spent for any other.
 MU1/P1 = MU2/P2 = ......... = MUn/Pn
Marginal Utility and the
Law of Demand
• What happens as price of a good
  rises?
• The amount of utility received per
  dollar spent declines, therefore
  people reduce their consumption of
  the good and consumes more of
  other commodities.
The Diamond-Water
Paradox
• Adam Smith noted that diamonds, who
    have little value in use, had a greater
    value than water, an element that is
    essential to life. Why should values not
    correspond to usefulness?
•   Although water provides more total
    utility than diamonds, it is marginal
    utility that dictates value.
•   Why do diamonds have greater
    marginal utility than water? Because
    diamonds are relatively scarce.
The Distribution of Income and
Interpersonal Utility
Comparisons
•   Jeremy Bentham (1748-1832) and the
    utilitarians
•   http://homepage.newschool.edu/~het/profil
    es/bentham.htm
•   Bentham offered the following argument for
    an equal distribution of income:
•   The diminishing marginal utility of income
    suggests that an equal distribution of income
    would maximize social welfare.
Problems with Bentham’s View
1. FROM BENTHAM: Equality diminishes incentives,
   thus diminishing long-run social welfare.
   Hence the distribution of income should be more
   equal, but not perfectly equal.
2. Interpersonal utility comparison - comparing the
   utility one person receives from a good with the
   utility another person receives from the same
   good.
• We cannot empirically measure utility. As a
   person accumulates more income we can expect
   marginal utility of each dollar to decline.
   However, we do not know the starting point. So
   it may not be the case that the marginal utility of
   an additional dollar for a rich person is
   necessarily lower than the marginal utility of an
   additional dollar for a poor person.
Why do individuals and nations trade?

• Each time a trade takes place, an apparent
    contradiction is expressed.
•   The buyer says the good is worth more
    than the money spent. The sellers says
    the money paid is worth more than the
    good.
•   How can this be explained? Diminishing
    Marginal Utility
•   Be able to explain this argument.
Consumer Theory:
Summarized
• Consumer theory gives us the
  theoretical foundation for the
  demand curve, which is critical to our
  understanding of the firm.
• Consumer theory allows us to see
  why individuals and nations trade.
• Consumer theory solves the
  diamond-water paradox.

								
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