Utility Flashcards
Impact of prices of different goods on MU and demand for a good
if the price of a substitute good fell, for example, it would be relatively cheaper than the current good. This means that the quantity demanded of the substitute would rise and it is substituted for the original good.
Hence the demand curve of the good would shift downwards, meaning that the consumer will be purchasing fewer units of the good at every price. This means that MU curve also shifts downward, so consume fewer regardless of MU yielded.
is the law of DMU still valid if non-price determinants of demand influence consumption?
non-price factors means the DC and hence MU curve will shift upwards or downwards
this is because consumers consume more/less of the good at every price regardless of the utility they gain from that level of consumption
the downward sloping nature of the demand curve is retained, which means the inverse relationship between quantity and MU still exists
therefore, this suggests that DMU still holds unless the good is an exception to the law of demand
how do non-price determinants alter the demand curve?
- affects position (shift)
- some factors may affect shape of the curve by making it more or less elastic, e.g. advertising
why basic idea of consumer equilibrium is not sufficient
Consumption of one good influenced by consumption of other goods (e.g. less income available to be spent
on other goods) - must consider the demand for a bundle of goods and services instead to understand consumption decisions
Therefore the EMP is useful, which still rests on the idea of DMU
When presented with two or more goods, consumer maximises TU by choosing a quantity of each good such that the MU per pound spent is equal for each
They do this by comparing the MU per pound of all products and consuming a given product as long as it has the highest marginal valuation. Eventually, the marginal valuation will fall DUE to DMU, so it is substituted for by the current highest valued product
what is consumer equilibrium?
maximize total utility while facing income and price constraints of the goods and services that the consumer wishes to consumer, and there is no incentive to change this level of consumption
for a single commodity, achieved when P=MU (explain why increasing/decreasing consumption is not ideal)
for multiple commodities, occurs when MU/£ is equal for all goods (explain that there is no other way income can be reallocated to maximise TU)
*NOTE: for a question on this -Consideration of the assumptions: rationality,
sovereignty, the ability to measure utility, the relation between utility and price.
equi-marginal principle
consumer
maximises utility by
consuming at the point
where the marginal
utilities per dollar from
each of the two goods
are equal
why do we need the EMP?
When presented with the choice of consuming two goods, the individual sets out to maximise the utility received from both. The quantity chosen of one good affects the demand for the other, since the consumer faces a budget constraint.
We cannot set MU=P here because the decision on one good affects the position of the MU curve for the other good because of the linkage through the budget
constraint
therefore the EMP allows the consumer to be best off given their budget constraints
derivation of demand curve from EMP
- draw a schedule of goods with prices for each, MU for each and budget –> learn a simple example
- show that if the price of one good were to change to x, then there would be a new point of consumer equilibrium for that good
- this is another point on that good’s demand curve
- the demand curve for the other good will shift in/out because of the budget constraint: consuming more/less of the one good will mean you have to consume less/more of the other good to maximise the utility you enjoy from your budget
Limitations of MU Theory
4 main
- Assumes utility is perfectly quantifiable - is not
- Utility is subjective so it is difficult to apply individual demand curve to the whole market
- Consumption of one good influenced by consumption of other goods (e.g. less income available to be spent
on other goods) - must consider the demand for a bundle of goods and services to understand consumption decisions –> EMP useful - Exceptions to DMU and hence demand e.g. addiction, hobbies/collectors items - means that MU and hence DC not downward sloping! - use for derivation questions
assumes amount of utility that one unit of money can bring you) is constant but this will vary with inflation (inversely related)
not helpful to look at one good in isolation since consumption decisions are inter-connected - EMP more useful
Limitations of EMP
- Is utility quantifiable?
- Consumer rationality - influences other than MU
- Difficult to apply EMP to more than two good (could consider the choice as being good A vs ALL other goods)
- Utility is subjective so it is difficult to apply individual demand curve to the whole market
- Exceptions to DMU - upward sloping demand curve
why is behavioural economics useful?
if firms can understand what induces people to behave in certain ways, they
may be able to influence their spending.
Helps governments w/ designing policies where they want to
influence behaviour
what exists in a state of disequilibrium where P=/= MU?
If p>mu, then producer surplus exists because consumer is paying more than the satisfaction they receive.
if p<mu, then consumer surplus exists because consumer receives more satisfaction than they paid for
total utility
total satisfaction gained from the consumptions of all give units of a G/S WITHIN A GIVEN TIME PERIOD
use DMU to explain the downward slope of the demand curve
key: inverse relationship; willingness to pay
- define DMU
- assume rational consumer will only pay an amount equal to the MU they receive from consumption of that unit
- if MU falls with each additional unit, this thus reduces the consumers willingness to pay
- will only consume more units at a lower price
- hence Q demanded and price are inversely related, explaining the downward slope
link PED to the demand curve derived from MU theory
as price falls, consumers are willing to purchase more additional units of a G or S as the price reflects the falling MU they obtain from that unit
however the extent to which they increase consumption will depend on the PED of that good, and how quickly MU falls with extra consumption
e.g. water has higher MU for a much larger range of units consumed compared to diamonds, for which MU declines very quickly
