Utility maximisation Flashcards
Consumer behaviour -> Individual economic decision making -> Microeconomics
What is the core assumption of utility maximisation in economics?
Consumers aim to maximise utility (satisfaction or welfare) from the goods and services they consume. This assumption aligns with traditional economic theories where self-interest guides decisions, and maximisation reflects rational behaviour, which is central to orthodox economics.
How can utility maximisation be viewed in terms of minimising behaviour?
Maximising utility can be recast as minimising the cost or expenditure needed to achieve the same level of utility. The framework used (maximising vs. minimising) depends on analytical convenience. For example, maximising utility from a basket of goods can be viewed as minimising expenditure for a specific utility level.
What constraints do consumers face in achieving utility maximisation?
Consumers face several constraints in achieving maximum utility:
- Limited Income: Even wealthy individuals face finite income, restricting what they can purchase, with opportunity costs.
- Set Prices: Consumers are price-takers and cannot influence prices, limiting purchasing power.
- The Budget Constraint: Represents trade-offs consumers face, assuming all income is spent with no borrowing or saving.
- Limited Time: Time scarcity restricts consumption choices, requiring prioritisation of goods.
What is satiation, and how does it relate to marginal utility?
Satiation is the point where additional consumption yields no additional utility, and beyond this point, further consumption leads to disutility (negative utility). Marginal Utility (MU) refers to the additional utility gained from consuming one more unit of a good, which diminishes as consumption increases, known as the Law of Diminishing Marginal Utility.
How do consumers optimise utility subject to constraints?
Consumers optimise utility by allocating their income to achieve the highest utility level. This is done by equating the marginal utility per unit of currency (MU/P) across goods, ensuring that the last dollar spent on each good provides the same marginal benefit.
What is opportunity cost in the context of utility maximisation?
Opportunity cost is the value of the next best alternative foregone when a choice is made. It drives trade-offs in consumption decisions, as consumers must choose how to allocate their limited income to different goods.
What are indifference curves, and how do they relate to utility maximisation?
Indifference curves represent combinations of goods that provide the same level of utility. Higher curves indicate higher utility levels. Utility maximisation occurs where the budget line is tangent to the highest attainable indifference curve, reflecting the point of optimal consumption.
What is the significance of the budget line in utility maximisation?
The budget line represents the affordable combinations of goods given a consumer’s income and the prices of goods. The gradient of the budget line reveals the opportunity cost of consuming one good over another, showing the trade-offs involved in utility maximisation.
What is consumer equilibrium in the context of utility maximisation?
Consumer equilibrium is the point where utility maximisation occurs within budget constraints. It reflects optimal consumption choices where the consumer achieves the highest possible utility given their income and the prices of goods.
What effect do income changes have on demand for goods?
- Normal Goods: Demand increases as income rises.
- Inferior Goods: Demand decreases as income rises.
What are the substitution and income effects in response to price changes?
- Substitution Effect: Consumers shift to cheaper alternatives when the price of a good rises.
- Income Effect: Changes in real purchasing power (due to price changes) affect demand, as consumers can afford more or less depending on their new income level.
How does behavioural economics challenge traditional theories of utility maximisation?
Behavioural economics highlights that individuals may act irrationally, contrary to traditional assumptions of rationality. Examples include biases such as the sunk cost fallacy or present bias, which influence economic decision-making and can prevent consumers from maximising utility effectively.
What diagrams are useful for understanding utility maximisation?
Key diagrams include:
- Indifference Curves and Budget Line: Illustrates consumer equilibrium.
- Marginal Utility Graph: Shows diminishing marginal utility as consumption increases.
- Income and Substitution Effects Graph: Demonstrates changes in demand when prices change.
