Consumer & utility

Exam Questions 2006 sq 6 2005 sq 4

Assumptions made about consumers

1. consumers act rationally

2. consumers have limited incomes

3. consumers aim to get their maximum utility from the way they spend their incomes

4. consumers are subject to

The Law of Diminishing Marginal Utility

Utility Marginal Utility

is the amount of benefit or satisfaction derived from the consumption of a good or service.

is the increase in benefit or satisfaction derived from the consumption of an extra unit of the good or service.

states that as a consumer consumes extra units of a good, then at some stage the marginal utility will decrease.

The Law of Diminishing Marginal Utility

Assumptions underlying the law of diminishing marginal utility

1. Other factors affecting utility do not change:

The law assumes that other factors which affect a consumers utility do not change including;

Income levels Nature of successive units of the product Consumers taste

2. It does not apply to addictive goods or medicines:

The MU of addictive goods continuously increase as consumption increases.

With medication you may not get full utility until the last tablet is consumed.

3. It applies only after a certain point called the origin:

The “origin” is the minimum quantity which can be used effectively.

Until this stage has been reached, marginal utility may not diminished.

Eg. a full apple not a bite. a full bowl of cereal not a spoonfull.

4. Sufficient time has not elapsed between consumption of successive units:

If a person eats a number of apples, each addition apple will give diminished utility if eaten one after the other on the same day.

However , if they are eaten one per day then the MU may not diminish.

Equilibrium Means the ideal situation to be in

under any given set of circumstances.

When consumers are in equilibrium it means that they are getting the maximum possible utility from their income.

The Principal of Equi-Marginal Utility

The Law of Equi-Marginal Returns:

States that a consumer will be in equilibrium when his/her income is spent in such a way that the ratio of marginal utility (MU) to price (P) is the same for all goods.

MU coke =Price of coke

MU crisps =Price of crisps

MU chocPrice of choc

DEMAND CURVE The shape of the normal

demand curve reflects the equi-marginal principle.

If the price of one good falls while the other remain constant, more of the relatively cheap good will be bought until the MU/P is the same for all goods bought.

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Exam Questions 2011 Section B Question1

Give

Rational choice theory Self-interest Use reason “rational calculator” Make choices How – benefits v costs & marginalism Yesterday is gone tomorrow hasn’t

happened yet so focus on now Utility/satisfaction

Humans As you make choices something is

going to happen to you Diminishing returns i.e. songs 3 minutes – get fed up Films 2 – 3 hours or mini-series….. Cost rise as you make choices (PPF)

Consumer Demand Constraint – income Options – freedom of choice Self-interest Cost & benefits Cost (social) – price Benefit (individual)

Market mechanism Compete I want to pay low price,

they want the highest Price (scarce) – level of technology

& all the producers Revealed preference

Individual focuses a lot of energy on the costs however they must think of other things.

Most efficient choice build in all the info necessary to choose

S, C, Ex, Y,…….

Elasticity If price change how do these

rational choice makers change their behavior?

If price chances that changes your rational calculator

Inelastic – don’t care Elastic – really interested