4.1.2 Individual economic decision making Flashcards
What is utility in economics?
Utility refers to the degree of benifit or satisfaction that an individual receives from an economic act.
Define marginal utility
The additional utility generated from consuming an extra unit of a given good
What is consumer utility?
A consumer’s utility is the total satisfaction received from consuming a good or
service.
Explain how the fact that the demand curve is downwards sloping can be explain through the concept of utility:
Consumer utility is the amount of satisfaction consumers receive from consuming a given good or service. As consumers are assumed to be rational, and aim to maximise their utility, consumers are willing to pay as much as the monetary value of utility they receive for consuming a given good.
Due to the law of diminishing marginal utility however, the marginal utility consumers recieve from consuming one additional unit of a given good falls as the number of units consumed increases. As such, the monetary value rational consumers are willing to pay for a given good falls as the quantity of units increases. As the demand curve shows the relationship between price and quanity demanded, this will therefore reflect a downwards sloping demand curve, with consumers willing to pay lower prices as quantity increases.
What is total utility?
The total utility received from consuming X units of a given good or service
What is the law of diminishing marginal utility?
Diminishing marginal utility says that, as you consume more of a good, the extra satisfaction/utility/benefit from an additional unit will decrease.
What is utility maximisation?
This is an assumption that consumers are rational and aim to generate the maximal possible utility from an economic decision
How do incentives influence economic activity?
Economic agents respond to incentives, which means resources are allocated such to maximise the utility to each agent.
When incentives are not given properly, resources will be misallocated
For the entrepreneur in a firm what is the incentive for taking risks
For the entrepreneur in a firm, the incentive for taking risks is profit.
Define Asymmetric Information
give an example
When two economic agents have different amounts of information about a given economic decision.
eg: a antiques expert and teenage shop assistant
or
stakeholders and the director of a company. they have aymmetric information about the directions decisions for the firm
What is incomplete information?
Incomplete information - when one party does not have full information about the benefits and costs of of decision e.g. Incomplete information in the past about the health risks of smoking leading to their overconsumption
What is imperfect information?
Imperfect Information - Where buyers or sellers lack the full information required to make an informed economic decision (information is missing)
This does not mean one party has more information than other, just than full information is not available to anyone.
What two issues can asymmetric information be linked to? (dont explain just state)
Market Failure and Principle Agent Problem
Explain how asymmetric information can be linked to market failure
Impact on Markets - Asymmetric Information
When sellers have more information about their producers than buyers, buyers do not know if they are getting genuinely good quality products, or poor quality products with lots of defects.
Buyers therefore face the risk of unknowingly purchasing a low quality product for a much higher price than its value. Because of this risk stemming from the asymmetric information, they are only prepared to offer to pay average prices for better than average quality products on the market.
Owners of higher quality products therefore tend not to sell them because they cannot get a high enough price
This means the majority of higher quality products get removed off the market, and only the lower quality products which are around the value which buyers are willing to offer remain
As such, the demand in the market reduces (as people are willing to pay much lower on average prices), and the market becomes saturated with lower quality products. This may even cause the market to disappear completely, as people do not want to purchase such low quality products.
Explain how assymetric information can be linked to the principle agent problem
However, given there is Asymmetric information between the shareholder and managers, this does not always occur, and the managers may run the firm in order to maximise their own personal objectives.
If information was perfect, the shareholders (the principal) would know everything - everything the manager (the agent) are doing. So the principal would be able to monitor the agent and make sure the agent maximises company profits.
However, given there is Asymmetric information, the shareholders do not know exactly how the company is being managed
