Demand and Utility Flashcards
What is utility?
Benefit and satisfaction
What two key factors determine the consumption choices made by households?
Their budget constraint
Their preferences
How does the budget constraint affect consumption choices made by households?
Each person has a given amount of money they can spend and sometimes can’t influence price changes made by the sellers.
What is total utility (TU)?
What is marginal utility?
The total benefit of satisfaction that a person gets from the consumption of a good or service.
The benefit gained from consuming one additional unit of a good or service.
How do you measure marginal utility?
The Change in total utility over the change in quantity
What is the law of diminishing marginal utility?
The more I consume of something, the less utility each additional unit will give me, if the consumption of everything else is kept constant.
How do you measure TU?
Arbitrary units.
What does the gradient of the budget line show us?
The gradient shows us how many units of y I have to give up for one additional unit of x.
It is the boundary between affordable and unaffordable.
Where is affordable on the budget line?
On and inside the line.
Where is unaffordable on the budget line?
On the outside of the line.
What does it mean to be on the inside of the budget line?
You are saving.
Is it better to be in or on the budget line?
On because it means you are maximising utility/satisfaction.
What is marginal utility on the budget line?
The slope
What is total utility on the budget line?
the function (?)
What point on budget graph should I be?
- On the line
- Marginal utility per dollar spent should be equal
Mu(a)/P(a) = Mu(b)/P(b) etc.
If the marginal utility of hamburgers is greater than the marginal utility of pizza what should you do?
What is this called?
Buy more hamburgers with the money previously used to buy pizza, thus buy less pizza until marginal utility is equal.
This is called the marginal utility theory.
What supports the marginal utility theory?
The law of demand because as the price falls you buy more of the good.
How can you calculate excess demand/supply?
- Take the price that is given and sub it into demand/supply function
- See which one is bigger (D>S shortage, S>D surplus)
- Subtract one from the other
What does it mean if the slope decreases?
The function increases at a decreasing rate
What does it mean if MU reaches 0?
TU is horizontal which means its constant. The slope is at max or min.
What happens to the graph if there is a change in income?
There is a shift parallel
Which way does it shift if income increases?
Up right
Which way does it shift if income decreases?
down left
What happens if the price of pizza increases?
The relative price decreases
What is the slope?
The marginal utility and the relative price
What happens when the relative price decreases?
The slope decreases
If the marginal utility per dollar spent of x is equal to the marginal utility per dollar spent of y, and the price of x falls, what happens?
The marginal utility per dollar spent of x increases (since its MU/px) and so you should buy more of x and less of y until equality is restored.
how do you calculate the gradient of the budget line?
Rise/Run
Px/Py therefore it is relative price
How can you calculate MU per dollar spent of the good?
The MU obtained from the last unit of the good, divided by its price.
What is the MU/P ratio?
The utility gained when another dollar is spent on the good, or the utility lost when spending on the good is out by a dollar.
At a consumer equilibrium what is true?
There is no other affordable choice that would make the individual better off.
If you are at consumer equilibrium, would you change purchases?
No, not unless some other factor (prices, preferences, income) changes
Why do we not spend all our money on the same goods?
We would completely drive down their marginal utility
What are the two parts of budget constraint?
- Income is limited
2. You can’t always influence the price of goods
What does the budget line show us in general?
Describes the limits to the household’s consumption choices
With what unit do we measure utility?
We use hypothetical units called utils
What does the MU theory assume?
That individuals make their spending decisions in such a way as to maximise their total utility. Meaning they make themselves as well off as possible given their resources.
Predictions of the MU theory?
When the P of a good rises, the Qd for that good decreases.
When the P of a good rises, D of a substitute increases.
When income increases, this increases the number of affordable combinations
How do you predict the impact of a change in P?
- Determine the new combinations that use up all of the income at the new prices
- Calculate the MU per dollar spent
- Find where the MUs per dollar spent are equal
What is the difference between individual demand and market demand?
Individual demand is the relationship between the quantity demanded of a good by a single individual and the price
Market demand is the relationship between the quantity demanded of a good and the price. It shows the total quantity demanded of a good by all consumers at each price level.
It is a horizontal summation of all the individual demand curves.
What is the paradox of value?
The apparent contradiction that although water is more useful than diamonds, diamonds are far more expensive.
Explain the paradox of value
Water is more abundant than diamonds and so it costs less.
This is explained by the law of diminishing MU.
The supply of water is large, this the consumption of water usually takes place at a low MU. TU of water is very high. Therefore there is no need to sacrifice very much for an additional gallon of water.
Supply of diamonds is (supposedly) limited so the consumption takes place at a high MU. TU of diamonds is very low.
What is value?
The value of one more unit of a good or service is the same thing as its marginal benefit. So willingness to pay.
