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Econ: What is Utility Maximization? 4 Views


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What is Utility Maximization? Utility maximization is the technical term for the colloquial expression, “bang for the buck”. This refers to getting the most value, enjoyment or usage for the least amount of expenditure in individual purchasing choices. The indifference curve is a theoretical graphic comparison between two goods or services that deliver similar levels of utility, satisfaction or enjoyment, in order to quantify preferences.

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Transcript

00:00

And finance Allah Shmoop What is utility maximization All right

00:09

Those three tennis courts the four swimming pools and the

00:12

porcelain fountain imported from Milan You own them all Not

00:16

to mention a G six with a hot tub and

00:20

your own basketball team So think of your resource is

00:23

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

00:29

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

00:32

too worried about using your pencil after you sharpen it

00:35

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

00:37

it out you just toss it rather than use another

00:40

inch Well utility maximization has to do with decisions consumers

00:44

make as they spend Their limited resource is all right

00:48

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

00:51

have to figure out how to divide it up to

00:54

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

00:59

other stuff you need Thio live So the basic question

01:02

with regard to utility maximization for you Well how do

01:05

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

01:09

out of it In other words how do they maximize

01:11

utility Or how do you do this Utility maximization has

01:14

to do with value Or rather how you allocate precious

01:18

resource is AII Cash So it produces the most value

01:22

to you the consumer Or set another way How do

01:25

consumers get the most satisfaction from spending their hard earned

01:28

dollars Well question How many gold plated toilets is Jeff

01:32

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

01:36

limited by budget He is however limited by the happiness

01:40

Each additional gold plated toilet gets him Well the guy

01:44

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

01:47

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

01:50

about resource allocation He just buys whatever he wants No

01:54

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

01:58

well but a normal person would probably not take both

02:01

the pink and the green Buffy and Muffy yachts In

02:03

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

02:06

of shame Normal people have constrained budgets and before they

02:10

spend their dough they predicted given level of satisfaction they

02:13

quote achieve unquote from hitting that by now button What

02:17

they have to spend is essentially a kind of mathematical

02:21

constraint on there Happiness or utility or ability to make

02:25

their life better What they have to spend is a

02:28

constraint on their budget They need to make tradeoffs among

02:32

the items they need to buy based on the happiness

02:35

each additional unit of whatever gets them So now back

02:39

to the average Joe liberal arts major your big tradeoff

02:42

choices might be more about buying ramen noodles in bulk

02:46

or getting the soft toilet paper hint by the ramen

02:51

You can always borrow toilet paper from the Burger King

02:55

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

02:58

This dynamic is called a budget constraint beautifully graphically illustrated

03:03

here for your viewing pleasure Yeah Check this out And

03:06

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

03:10

much constraint you know financially yet Well utility maximization is

03:14

all about these budget choices The goal of utility maximization

03:18

is to get the most value from the money you

03:21

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

03:24

between toilet paper and Rahman Here we have a budget

03:28

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

03:31

an indifference curve which measures the happiness we get from

03:34

each and where the slope of the indifference curve is

03:37

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

03:40

maximum utility IAEA happiness within our budget constraint Getting all

03:44

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

03:48

You have fifty boxes your last fifty bucks and it

03:50

has to last you nine days until your next liberal

03:54

arts style paycheck comes Costco the discount retailer has super

03:59

bulk boxes of Rahman on sale in a cost for

04:01

one month worth of noodles Well fifty bucks which is

04:04

grey but for the fact that you will be evicted

04:07

in an hour And the cost to remain in your

04:09

hovel into the freeway for nine more days happens to

04:12

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

04:16

the head bum to tell the other bums not to

04:19

beat you senseless at night and steal your liver while

04:22

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

04:24

trade off here You can either eat or you Khun

04:27

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

04:30

there should be a tradeoff you could make where fell

04:33

Maybe you share a cardboard box with another bum for

04:36

twenty five dollars for nine days and spend the remaining

04:39

twenty five dollars on the well two weeks worth of

04:41

noodles that will get you through until you can collect

04:44

your next paycheck As you rue the day you know

04:47

that you did that whole liberal arts major thing Well

04:49

because economists are economists they have a bunch of mathematical

04:52

formulas to optimize the budget allocation of your precious dollars

04:56

The basic notion behind this math revolves around the idea

04:58

that consumers will allocate their money so that they get

05:01

the most marginal utility for each dollar they spend Right

05:06

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

05:08

to them Okay Last concept for understanding utility maximization here

05:12

for marginal utility is the amount of extra use you

05:15

get out of buying mohr of something like you need

05:18

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

05:22

like forty pounds of it to keep you alive For

05:24

just nine days A storage locker full of Rahman will

05:27

not do much good for you It would just sit

05:29

around doing nothing right What One pair of pants is

05:32

good for keeping your legs warm and making sure you

05:35

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

05:37

done that But a thousand para pants Well just wasteful

05:40

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

05:44

pair of you know khaki Dockers So utility maximization involves

05:49

trying to get the most value Out of limited resource

05:51

is such that the N plus one unit then begins

05:55

to decline dramatically in value art Example Like if you

05:59

need two thousand calories a day to basically maintain your

06:02

current weight and one packet of Rahm and his five

06:04

hundred calories Well then if you need to survive nine

06:07

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

06:10

days or thirty six packets to just keep you alive

06:13

until your next paycheck after nine days At that point

06:16

you hope you can afford to make a change in

06:18

your life and lifestyle But for now you realize that

06:21

you would probably die or at least suffer greatly If

06:23

you went with no Roman for all nine days and

06:26

just tried to survive on water you would gain great

06:29

utility from having at least one packet today for nine

06:33

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

06:35

weight in living on five hundred calories a day That

06:38

the storage locker of a thousand docker pants would have

06:41

almost no hands that fit you anymore Yeah you would

06:44

continue to gain meaningful marginal value from that second and

06:48

third packets of Rahman a day getting you to a

06:50

fifteen hundred calories a day Such that Well you might

06:53

only lose a few pounds over the course of those

06:56

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

06:58

just fine And after for four packet today well the

07:01

value of those Rahman noodles begins to decline massively or

07:05

set another way there Marginal utility than approaches Zero Well

07:09

this set of calculations mirrors the marginal utility value model

07:13

with the goal of getting the most marginal utility out

07:16

of each dollar or the most rum and out of

07:19

the dollar which is actually quite a bit of Roman

07:24

and

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