Marginal Utility Theory

Question 1

What is total utility?

Answer 1

The total satisfaction gained from all the units of a commodity that they consumed within a given time period

Question 2

What is marginal utility?

Answer 2

The additional satisfaction gained from consuming one extra unit of a commodity within a given time period.

Question 3

What is a util?

Answer 3

An imaginary unit of satisfaction gained from consumption of a good created in order to give us a means to measure utility

Question 4

What is the principal of diminishing marginal utility?

Answer 4

The more of a good a person consumes, the smaller the marginal utility will be

Question 5

Marginal consumer surplus

Answer 5

The difference between what you are willing to pay for an additional unit of a good and what you are actually charged. (Marginal utility- price)

Question 6

Total Consumer Surplus

Answer 6

Total utility - total expenditure on the good

Question 7

What is another thing to describe the marginal utility curve as?

Answer 7

An individuals demand curve where utility is measured in money

Question 8

How is marginal utility calculated?

Answer 8

The first derivative of marginal utility

Question 9

At what point is total utility maximised?

Answer 9

Where marginal utility is 0

Question 10

At what point will a rational consumer continue to consume

Answer 10

When the marginal utility of consuming an extra unit of the good is equal to the price.

Question 11

What is the Equi-marginal principal?

Answer 11

That a consumer will get the highest possible amount of utility from a given income level when the ratio of marginal utilities is equal to the ratio of the prices of these goods.
MU(good A)/MU(good B)=Price (good A)/Price(good B)

Question 12

Indifference Curve

Answer 12

A curve showing all the combinations of two goods which all give the same level of utility as each other.

Question 13

Marginal Rate of Substitution

Answer 13

The amount of one good (y =) that a customer is prepared to give up in order to obtain one extra unit of another god (X). (Shown by the slope of the indifference curve).

Question 14

Why are indifference curves convex rather than linear?

Answer 14

The amount of good y that a consumer is prepared to give up to obtain an additional unit of good x (Marginal Rate of Substitution) decreases as good x increases as good x is no longer scarce instead it is plentiful while good y is becoming scarcer and scarcer so the consumer is more hesitant to give up good y.

Question 15

Diminishing Marginal Rate of Substitution

Answer 15

The amount of good y that a consumer is prepared to give up to obtain an additional unit of good x decreases due to the principle of diminishing marginal utility. The more of good x they consume the lower the utility from this good will be so in order to give up some of good y they will need a larger proportion of good x in order to keep the level of utility constant.

Question 16

Equation for Marginal Rate of Substitution

Answer 16

MU good x/ MU good y (Change in Y/Change in X)

Question 17

Indifference map

Answer 17

A graph showing a whole set of indifference curves, the further away a curve is from the origin, the higher the level of satisfaction is to be gained from consuming any combination of goods along that curve.

Question 18

Budget line

Answer 18

A graph showing all the possible combinations of two goods that can be purchased at given prices and for a given budget.

Question 19

What does the slope of the budget line show?

Answer 19

The ratio of the Price of good X to the Price of good Y.

Px/Py

Question 20

Where is the optimum consumption point along the indifference map?

Answer 20

The point which is tangential to the budget line so the consumer consumes along the indifference curve that gives them the highest level of utility that they can afford with their level of income.
At this point the slope of the indifference curve (MUx/MUy) is equal to the slope of the budget line (Px/Py) so the optimum consumption point is where Px/Py= MUx/MUy

Question 21

Income consumption curve

Answer 21

A line showing how a persons optimum level of consumption of two goods changes as their income changes (assuming prices of the goods remain constant)

Question 22

How can you tell that both the items in the indifference curve are normal goods?

Answer 22

If the income-consumption curve is positively sloped the consumers demand for both goods increase as their income rises, meaning they are normal goods.

Question 23

When (in terms of marginal utility) will total utility begin to fall

Answer 23

When MU is negative

Question 24

Graphically, what is the total utility?

Answer 24

The point under the MU curve where the consumer would have been willing to pay for the good up until the amount of the good that they consume. (Consumer surplus+ total expenditure)

Question 25

Total consumer surplus (equation)

Answer 25

Total utility - Total expenditure

Question 26

What is the impact on an indifference diagram if the price of good x becomes cheaper?

Answer 26

The budget line becomes flatter as with the same level of income a higher amount of good x can be bought (the point at y stays the same).

Question 27

What is the impact on an indifference diagram if there is a shift in taste towards X and away from Y?

Answer 27

The indifference curve becomes steeper as the consumer is willing to give up a higher amount of good y to get more of good x

Question 28

What is the impact on an indifference diagram if there is a change in the optimum level of consumption resulting from a change in tastes?

Answer 28

There is a movement along the budget line from an old tangency point to a new one.

Question 29

Price consumption curve

Answer 29

A curve connecting all the different optimum points of consumption as according to changes in the price of a good (assuming that income and the price of the other good is constant)

Question 30

What are the two reasons why consumers consume less of a good when the price rises

Answer 30

The income effect and the substitution effect

Question 31

How does the income effect cause consumers to reduce consumption of a good as it gets more expensive?

Answer 31

At a higher price, consumers can’t afford to buy as much of the good with the same level of income. (Shown in budget line when it becomes flatter)

Question 32

How does the substitution effect cause consumers to reduce consumption of a good as it gets more expensive?

Answer 32

The good is now more expensive relative to other goods so consumers substitute alternatives for it.

Question 33

What is the impact of a high income and substitution effect on the price elasticity of demand?

Answer 33

The PED is more elastic.

Question 34

What are the signs of the income and sub effect for a normal good if the price of this good rises?

Answer 34

They are both negative (both effects lead to a lower level of consumption of the good).

Question 35

What are the signs of the income and sub effect for an inferior good if the price of this good rises?

Answer 35

The substitution effect is negative as the price of the inferior good has become more expensive relative to other goods so people may substitute this good for alternatives.
However the income effect is positive as it has a negative elasticity of demand so as income falls (in terms of the budget line) consumption increases

Question 36

What is a giffen good?

Answer 36

An inferior good that takes up an abnormally large proportion of a consumers budget.

Question 37

What is the effect of a rise in price of a giffen good?

Answer 37

Since it takes up a very large proportion of the consumers income it causes a very large income effect as the change in price has a significant effect on the consumers real income (income measured in terms of how much you can buy). So this income effect could be big enough to outweigh the regular substitution effect and a rise in the price of this giffen good could lead to an increase in demand.