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19 -- Part 2: The Logic of Individual Choice:
As you consume more of something, the marginal utility you get from it falls.
The marginal utilities of these activities will fall as you consume more pizza and read more.
The marginal utilities you get from the goods are changing as you vary your consumption.
I assume that the "goods" are divided.
This assumption is needed for marginal utilities to be fully specified.
When there is no clear winner, you have to adjust your spending.
You're in equilibrium when you maximize utility.
It's important to remember to maximize total utility only when marginal utility is diminishing.
The marginal marginal utility of all goods is zero as we consume more of an item.
Tell me your answer.
It takes more information than I've presented to achieve equilibrium by maximizing utility.
We need to know how much we have to spend on all those items and the marginal utility of alternative amounts.
Given our available resources, we can choose among alternatives.
In Table 19-1 we can see an example in which we have the information to make simultaneous decisions and maximize utility.
We have $7 to spend on ice cream cones and Big Macs.
There is a choice between ice cream and Big Macs.
The principle of diminishing marginal utilization in action can be seen in the table.
By following the rule that we choose the good with the higher marginal utility per dollar, we can quickly determine the optimal choice.
The table has the information needed to make simultaneous decisions.
As we consume more of it, we get the marginal utility from another decline.
Until the marginal utility of all goods is equal, adjust your choices.
We would only eat ice cream.
If we spent $2 on a Big Mac, we would get 20 units of utility.
The 10 units of utility per dollar from the Big Mac is better than the 7 units of utility per dollar we can get from ice cream cones.
We buy 1 Big Mac and 2 ice cream cones with our first $4.
Let's look at our sixth and fifth dollars.
We ask McDonald's if it will, and it tells us no, so we have to choose between two additional ice cream cones or a Big Mac.
Since the marginal utility per dollar of the fourth ice cream cone is only 2, it makes sense to spend our fifth and sixth dollars on another Big Mac.
We have one more dollar to spend and now we have 2 Big Macs and 2 ice cream cones.
7 additional units of utility can be obtained if we spend it on a third ice cream cone.
Since we only have a dollar and Big Macs sell for $2, this is our only choice if McDonald's only sells whole Big Macs.
McDonald's wants the sale and this time they will sell us half a Big Mac for $1.
The answer is no.
The third ice cream cone gives us 7 units of utility per dollar, whereas half of the next Big Mac gives us only 5 units.
The seventh dollar is spent on an ice cream cone.
The marginal utilities per dollar are the same for both goods and we're maximizing total utility with these choices and $7 to spend.
Our total utility is made up of 34 from 2 Big Macs and 53 from 3 ice cream cones.
The $7 we have to spend is the most total utility they give us.
The utility maximization rule says to maximize utility by adjusting your choices until the marginal utilities per dollar are the same.
The marginal utility between the last Big Mac and the last ice cream cone is equal.
We know we can't do any better because the marginal utility per dollar of each choice is the same.
We could increase our total utility if we switched to one of the two choices.
Our example only involved two goods, but the reasoning can be extended to many other goods.
The principle of rational choice among many goods is an extension of the principle of rational choice applied to two goods, according to our analysis.
The principle of rational choice is to consume more of the good that provides a higher marginal utility per dollar.
When the marginal utili ties are equal, stop adjusting your consumption.
The per son's decision of how much to consume is combined with the person's choice of how much to work.
When you say you want a car but can't afford it, economists ask if you're working two jobs and saving money to buy it.
If you aren't, you're showing that you don't really want a car, because you'd have to do a lot to get it.
The rule for maximizing utility relates to the laws of demand and supply.
We start with demand.
The law of demand says that quantity is related to price.
When the price of a good goes up, we consume less of it.
The law of demand is related to the principle of rational choice.
It goes down.
The principle of rational choice is no longer valid when the price of a good goes up.
The rule is no longer satisfied.
The marginal utility we get from the good whose price has gone up must be raised to satisfy our utility-maximizing rule.
The marginal utility of ice cream rises and the marginal utility of a Big Mac falls as we reduce the number of ice cream cones and Big Macs.
If you are in equilibrium you can increase your utility by consuming less.
When the price of a good goes up, and the price of one good goes down, how consumption of that good will go down.
As price falls, other things are constant.
As price rises, quantity demanded falls.
The rise in price is one of the effects that we have to cut back on.
The price of ice cream has gone up.
The law of demand is based on the substitution effect.
Let's assume that someone compensates us for the increase in the price of ice cream cones.
We'll assume someone gives us an extra $3 to compensate for the rise in price since it would cost $10 to buy what $7 bought previously.
The income effect is eliminated because we are not any poorer because of the price change.
We can buy 2 Big Macs and 3 ice cream cones now that we have $10, because we did before.
If we do that, our total utility is once again 87, which includes 34 units of utility from 2 Big Macs and 53 units of utility from 3 ice cream cones.
Our total utility goes up to 44 from 3 Big Macs and 46 from 2 ice cream cones, for a total of 90 units of utility.
We've increased our total utility by taking ice cream out of the equation.
Even though we were given more money, we didn't buy the same amount of ice cream cones because the price of ice cream went up.
The law of supply of factors of production, such as labor, indi utility and the price of supplying a good goes up, if there is diminishing marginal choice, you supply more of that good.
You are getting money in return for your time, land, or other factor of production in supply decisions.
One final example is how much labor you should give to the market.
If you work another hour at your part-time job, you will get another $8 and you will be working 20 hours a week.
24 units of utility are given from the additional income from the final hour of work.
If you use that hour to study economics, you will get another 24 units of utility.
The wage per hour is the opportunity cost of studying because it is the price of studying.
Say that your boss offers to raise your wage to $8.25 per hour for work you can explain how you would do over 20 hours.
If your employer raises your wage, the price of studying will change the amount of work you get.
You can get more goods if you work an additional hour.
The marginal utility you get from an hour of work to 32 additional units is raised by those additional goods.
You work an extra hour.
Say your boss comes to you and asks you what it would take to get you to work more hours.
The law of supply is demonstrated by the supply curve shown in the margin.
There is a comparison of marginal utilities for various activities.
Say that an exam is coming and you haven't studied.
You're in good shape if you answered that it will shift to the left.
Rational choice is related to the opportunity cost concept that I presented in earlier chapters.
The principle of rational choice states that a forgone opportunity is essentially the marginal utility per dollar you forgo from that, to maximize utility, choose.
The opportunity costs of the alter natives are the same if the marginal utilities per dollar spent are equal.
The principle of rational choice is stated in this way: To maximize utility, choose goods until the opportunity costs of all alternatives are equal.
A spe cific measure of utility doesn't exist because people don't use the terminology.
They use the opportunity cost of the benefit all the time.
The higher the marginal utility, the more you need it.
Understanding a theory involves more than understanding how a theory works; it also involves understanding the limits of the assumptions underlying the theory.
Behavioral economists are questioning some of the assumptions on which traditional economists' analysis of choice is based.
The assumptions include that decisions are costless, tastes are given, and utility is maximized.
Let's look at some of their questions.
The implicit assumption is that decisions can be made costlessly.
Rational choice makes sense when we limit our examples to two or three choices, as I did in this chapter.
We make hundreds of thousands of choices at the same time.
It doesn't make sense to apply rational choice to all of them at once.
428 Microeconomics would exceed our decision-making abilities.
It is only rational to do things without applying the principle of rational choice because of the cost of decision making.
We all save money by thinking about decisions.
Modern economists spend a lot of time researching.
A number of economists have come to rational choice following the work of rationality.
Rational ity is based on rules of thumb.
They say that many of our decisions are made with our minds.
The view of rationality has implications for interpreting and predicting eco Advertising.
One rule of thumb is "You get what you pay for."
We rely on price to convey quality information.
This reliance on price for information can lead to upward-sloping demand curves.
Do what you think smart people are doing if you don't know what to do.
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