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And finance Allah Shmoop What is utility maximization All right

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Those three tennis courts the four swimming pools and the

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porcelain fountain imported from Milan You own them all Not

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to mention a G six with a hot tub and

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your own basketball team So think of your resource is

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as being well infinite Mohr less so Utility maximization wouldn't

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come up much in your life That is You're not

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too worried about using your pencil after you sharpen it

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so that it's only two inches long before you throw

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it out you just toss it rather than use another

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inch Well utility maximization has to do with decisions consumers

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make as they spend Their limited resource is all right

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now you're this guy You get a modest paycheck You

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have to figure out how to divide it up to

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survive You've got rent food utilities entertainment and all the

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other stuff you need Thio live So the basic question

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with regard to utility maximization for you Well how do

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consumers budget they're spending in order to get the most

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out of it In other words how do they maximize

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utility Or how do you do this Utility maximization has

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to do with value Or rather how you allocate precious

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resource is AII Cash So it produces the most value

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to you the consumer Or set another way How do

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consumers get the most satisfaction from spending their hard earned

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dollars Well question How many gold plated toilets is Jeff

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Bezos founder of Amazon Limited to buy Answer He isn't

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limited by budget He is however limited by the happiness

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Each additional gold plated toilet gets him Well the guy

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has couple hundred billion dollars That's with a B in

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Amazon stock wealth so he doesn't spend a nanosecond worrying

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about resource allocation He just buys whatever he wants No

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no no Mr Yacht broker I'll take two of them

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well but a normal person would probably not take both

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the pink and the green Buffy and Muffy yachts In

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fact they wouldn't even be able to afford one yacht

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of shame Normal people have constrained budgets and before they

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spend their dough they predicted given level of satisfaction they

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quote achieve unquote from hitting that by now button What

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they have to spend is essentially a kind of mathematical

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constraint on there Happiness or utility or ability to make

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their life better What they have to spend is a

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constraint on their budget They need to make tradeoffs among

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the items they need to buy based on the happiness

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each additional unit of whatever gets them So now back

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to the average Joe liberal arts major your big tradeoff

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choices might be more about buying ramen noodles in bulk

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or getting the soft toilet paper hint by the ramen

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You can always borrow toilet paper from the Burger King

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bathroom or you know there's a newspaper laying around somewhere

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This dynamic is called a budget constraint beautifully graphically illustrated

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here for your viewing pleasure Yeah Check this out And

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here's a graph of Jeff Bezos Budget constraint Yeah not

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much constraint you know financially yet Well utility maximization is

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all about these budget choices The goal of utility maximization

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is to get the most value from the money you

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have available to spend As an example We're making tradeoffs

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between toilet paper and Rahman Here we have a budget

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that shows our trade offs of the two Well here's

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an indifference curve which measures the happiness we get from

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each and where the slope of the indifference curve is

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tangent to the budget constraint That's where we have the

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maximum utility IAEA happiness within our budget constraint Getting all

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this all right Now let's talk about another trade off

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You have fifty boxes your last fifty bucks and it

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has to last you nine days until your next liberal

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arts style paycheck comes Costco the discount retailer has super

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bulk boxes of Rahman on sale in a cost for

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one month worth of noodles Well fifty bucks which is

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grey but for the fact that you will be evicted

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in an hour And the cost to remain in your

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hovel into the freeway for nine more days happens to

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be exactly fifty dollars Well that's the amount You pay

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the head bum to tell the other bums not to

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beat you senseless at night and steal your liver while

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you're sleeping on the freeway there So you have a

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trade off here You can either eat or you Khun

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B Sheltered but you can't do both So in theory

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there should be a tradeoff you could make where fell

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Maybe you share a cardboard box with another bum for

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twenty five dollars for nine days and spend the remaining

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twenty five dollars on the well two weeks worth of

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noodles that will get you through until you can collect

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your next paycheck As you rue the day you know

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that you did that whole liberal arts major thing Well

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because economists are economists they have a bunch of mathematical

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formulas to optimize the budget allocation of your precious dollars

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The basic notion behind this math revolves around the idea

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that consumers will allocate their money so that they get

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the most marginal utility for each dollar they spend Right

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Last dollar it's going to go in the best place

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to them Okay Last concept for understanding utility maximization here

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for marginal utility is the amount of extra use you

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get out of buying mohr of something like you need

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some rahmon to keep you alive But you don't need

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like forty pounds of it to keep you alive For

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just nine days A storage locker full of Rahman will

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not do much good for you It would just sit

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around doing nothing right What One pair of pants is

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good for keeping your legs warm and making sure you

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don't get it You know arrested you know been there

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done that But a thousand para pants Well just wasteful

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There's not much marginal utility being gained from that thousand

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pair of you know khaki Dockers So utility maximization involves

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trying to get the most value Out of limited resource

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is such that the N plus one unit then begins

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to decline dramatically in value art Example Like if you

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need two thousand calories a day to basically maintain your

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current weight and one packet of Rahm and his five

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hundred calories Well then if you need to survive nine

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days while you'll want four packets a day for nine

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days or thirty six packets to just keep you alive

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until your next paycheck after nine days At that point

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you hope you can afford to make a change in

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your life and lifestyle But for now you realize that

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you would probably die or at least suffer greatly If

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you went with no Roman for all nine days and

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just tried to survive on water you would gain great

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utility from having at least one packet today for nine

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days But you'd realize that you have lost so much

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weight in living on five hundred calories a day That

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the storage locker of a thousand docker pants would have

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almost no hands that fit you anymore Yeah you would

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continue to gain meaningful marginal value from that second and

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third packets of Rahman a day getting you to a

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fifteen hundred calories a day Such that Well you might

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only lose a few pounds over the course of those

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nine days until you got that golden paycheck That'd be

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just fine And after for four packet today well the

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value of those Rahman noodles begins to decline massively or

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set another way there Marginal utility than approaches Zero Well

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this set of calculations mirrors the marginal utility value model

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with the goal of getting the most marginal utility out

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of each dollar or the most rum and out of

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the dollar which is actually quite a bit of Roman

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and

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