2.0. Law of Diminishing Marginal Utility

Question 1

Law of Diminishing Marginal Utility (Marginal Utility Theory)

Answer 1

As consumption increases the marginal utility derived from each additional unit declines.

Question 2

How does human nature explain Marginal Utility Theory

Answer 2

particular wants can be satisfied, we get bored, we get full, we prefer other things etc

Question 3

Law of Diminishing Marginal Utility Assumptions

Answer 3

Consumer is rational.

1) Utility is measurable (in monetary values).
2) Consumer’s tastes, preferences, habits and income remain the same.
3) Price of the product remains the same.
4) Any other factor of demand (e.g. advertising) remains the same.
5) Continuity in consumption (i.e. no breaks in consumption).
6) Marginal utility of money is constant.

Question 4

Marginal Utility =

Answer 4

change in total Utility / change in quantity consumed

Question 5

Relationship between Total and Marginal Utility

Answer 5

DRAW THE DIAGRAM :)

1) MU maximum, TU increases fastest rate.
2) MU decreases, TU increases at decreasing rate.
3) MU = 0, TU maximum.
4) MU is negative, TU is decreasing

Question 6

Utility

Answer 6

the satisfaction received from consumption.

Question 7

Total Utility meaning

Answer 7

the total satisfaction received from consuming a given total quantity of a good or service

Question 8

Marginal Utility meaning

Answer 8

the additional satisfaction gained from consuming an extra unit of a good or service.

Question 9

Diminishing Marginal Utility meaning

Answer 9

the fall in marginal utility as consumption increases.

Question 10

Marginal Utility Theory

Answer 10

examines the increase in satisfaction consumers gain from consuming an extra unit of a good.

Question 11

Marginal Utility =

Answer 11

Demand

Question 12

Deriving an individual demand curve

Answer 12

Consumption occurs when MU ≥ P

• As MU falls, a consumer is unwilling to pay as much for each successive product that is consumed.
• The price needs to fall for more consumption to occur.
• When MU Falls –> price needs to fall for quantity demanded to increase
• This explains why demand curves are downward sloping.
• Demand = Marginal Utility.
• Optimal point of consumption occurs when MU = P

Question 13

Exceptions to Law of DMU

Answer 13

• Desire for knowledge
• Inadequate initial consumption e.g. spoonful of water (mr L and pizza)
• Addictive products e.g. cigarettes / alcohol / drugs
• Collectors items e.g. comic books / stamps
• Money???

Question 14

Limitations of Law of DMU

Answer 14

• Only explains the demand for one good.
• Utility / satisfaction is difficult to measure.
• Consumers are not always rational.
• Consumers do not always aim to maximise their total utility.
• Prices are not constant.
• Tastes and preferences change over time.

Question 15

Evaluation of Law of DMU

Answer 15

Basis for the theory of the demand curve (MU = D)

• If a change (e.g. income) occurs MU curve will shift
• Humans often act irrationally:
• Impulse buying
• Brand loyalty
• Credit card purchases
• Intoxicants may involve rising MU
• Extremely rare items may involve rising MU
• Theory deals with one good, reality deals with many.

Question 16

Law of DMU and allocative efficiency

Answer 16

DRAW THE DIAGRAM

• When price = $8, quantity consumed = 6.
• However, P > MC ($8 > $4), therefore there is a deadweight loss (inefficiency) because MU > MC.
• Allocative efficiency occurs at $6 because P = MC. At this point, MU = MC.