Lecture Notes: Chapter 8 – Utility and Demand
Based on Microeconomics: Canada in the Global Environment (11th Edition)
Introduction
Why do people make the consumption choices they do? Why does water, which is essential for
life, cost less than diamonds, which are mostly ornamental? Economists use the concept of
utility to understand preferences and predict consumer behavior. This chapter introduces the
limits to consumption, explains how marginal utility affects choice, and explores how price
and income changes influence demand. It also addresses the paradox of value and presents
new behavioral insights into how consumers make decisions in real life.
1. Limits to Consumption and the Concept of Utility
Scarcity and Consumption
Even though we have many wants, we cannot satisfy them all due to limited income, fixed
prices, and finite time. These constraints limit our consumption choices.
Budget Constraint
A consumer's budget constraint shows all combinations of goods and services that can be
purchased with a fixed income at given prices.
Example:
If your income is $50, coffee costs $5, and muffins cost $2.50, then you can afford:
10 coffees, or
20 muffins, or
5 coffees and 10 muffins, etc.
This budget sets the boundary for consumption possibilities.
Utility and Preferences
Utility is a measure of the satisfaction or pleasure a person derives from consuming goods and
services.
Total Utility (TU): The total satisfaction from consuming a certain quantity of a good.
Marginal Utility (MU): The additional satisfaction from consuming one more unit of a
good.
, Example:
If eating a second slice of pizza increases your total utility from 10 to 16 units, the marginal
utility of the second slice is 6.
2. Marginal Utility Theory of Consumer Choice
Law of Diminishing Marginal Utility
As a person consumes more of a good, the marginal utility from each additional unit declines.
Example:
Your first cup of coffee in the morning may give you 10 units of utility. The second might give
7. By the fourth or fifth cup, the satisfaction is much lower.
This principle explains why demand curves slope downward—people are willing to pay less for
additional units of a good.
Consumer Equilibrium: Maximizing Total Utility
Consumers aim to maximize total utility within their budget. They allocate spending so that
each dollar spent gives equal marginal utility across goods.
Where:
MU = marginal utility
P = price
A and B = two different goods
This is called the equi-marginal principle.
Example:
If the marginal utility of a banana is 10 and it costs $1, and the marginal utility of an apple is 20
and it costs $2, both yield 10 utility per dollar. The consumer is in equilibrium.
Based on Microeconomics: Canada in the Global Environment (11th Edition)
Introduction
Why do people make the consumption choices they do? Why does water, which is essential for
life, cost less than diamonds, which are mostly ornamental? Economists use the concept of
utility to understand preferences and predict consumer behavior. This chapter introduces the
limits to consumption, explains how marginal utility affects choice, and explores how price
and income changes influence demand. It also addresses the paradox of value and presents
new behavioral insights into how consumers make decisions in real life.
1. Limits to Consumption and the Concept of Utility
Scarcity and Consumption
Even though we have many wants, we cannot satisfy them all due to limited income, fixed
prices, and finite time. These constraints limit our consumption choices.
Budget Constraint
A consumer's budget constraint shows all combinations of goods and services that can be
purchased with a fixed income at given prices.
Example:
If your income is $50, coffee costs $5, and muffins cost $2.50, then you can afford:
10 coffees, or
20 muffins, or
5 coffees and 10 muffins, etc.
This budget sets the boundary for consumption possibilities.
Utility and Preferences
Utility is a measure of the satisfaction or pleasure a person derives from consuming goods and
services.
Total Utility (TU): The total satisfaction from consuming a certain quantity of a good.
Marginal Utility (MU): The additional satisfaction from consuming one more unit of a
good.
, Example:
If eating a second slice of pizza increases your total utility from 10 to 16 units, the marginal
utility of the second slice is 6.
2. Marginal Utility Theory of Consumer Choice
Law of Diminishing Marginal Utility
As a person consumes more of a good, the marginal utility from each additional unit declines.
Example:
Your first cup of coffee in the morning may give you 10 units of utility. The second might give
7. By the fourth or fifth cup, the satisfaction is much lower.
This principle explains why demand curves slope downward—people are willing to pay less for
additional units of a good.
Consumer Equilibrium: Maximizing Total Utility
Consumers aim to maximize total utility within their budget. They allocate spending so that
each dollar spent gives equal marginal utility across goods.
Where:
MU = marginal utility
P = price
A and B = two different goods
This is called the equi-marginal principle.
Example:
If the marginal utility of a banana is 10 and it costs $1, and the marginal utility of an apple is 20
and it costs $2, both yield 10 utility per dollar. The consumer is in equilibrium.
