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When I go into the grocery store why
do I buy 12 cans of pop, 3 frozen pizzas, and 1 pound of
hamburger? Why don't I buy 12 pounds of hamburger and 1 can
of pop? In this lesson we will use benefit-cost analysis to
understand why we buy what we do. We will calculate the
marginal benefits (MB) of consuming something and the
marginal costs (MC) of consuming something. (Remember: all
costs in economics are opportunity costs.)
If our goal is to maximize our
satisfaction we will consume the quantity of goods and
services where MB = MC.
First, we will examine the benefits
we get from consumption. Economists call these benefits
"utility". We will calculate and graph total utility (TU)
and marginal utility (MU). As always, be sure you understand
the SHAPES of these graphs. Remember: Define, Draw,
Describe.
Then, we will use the utility
maximizing rule,
MUx/Px = MUy/Py = MUz/Pz =
. . . ,
to calculate how much we should buy
in order to maximize our satisfaction (utility).
Be sure that you can see that the
utility maximizing rule is really just a version of benefit
cost analysis, MB=MC. If I am thinking about going skiing
today, the MB would be the extra utility that I get from a
day of skiing: MBskiing = MUskiing. Since all costs are
opportunity costs, the marginal cost of skiing would be the
utility that I would lose because I am not doing something
else like going to a movie with my wife: MCskiing =
MUmovie.
Finally, why do we divide the MU by
the price? It doesn't make sense to compare a $45 ski ticket
with a $12 movie ticket. By dividing by price we end up
comparing $1 worth of skiing with $1 worth of a
movie.
So, to maximize my utility I should
go skiing and go to movies with my wife so that
the:
MUskiing/Pskiing=
MUmovie/Pmovie.
Even though MUx/Px = MUy/Py
looks different than MBx=MCx, it is really the same
thing. Be sure you do the exercises in the yellow pages.
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