A Level Economics Unit 7: Utility - Price, Consumption & Demand | PDF

A Level – unit 7 The price system and the macroeconomy 7.1 Utility 7.1.1 definition and calculation of total utility and marginal utility 7.1.2 diminishing marginal utility 7.1.3 equi-marginal principle 7.1.4 derivation of an individual demand curve 7.1.5 limitations of marginal utility theory...

A Level – unit 7 The price system and the macroeconomy 7.1 Utility 7.1.1 definition and calculation of total utility and marginal utility 7.1.2 diminishing marginal utility 7.1.3 equi-marginal principle 7.1.4 derivation of an individual demand curve 7.1.5 limitations of marginal utility theory and its assumptions of rational behaviour 1. What is utility? Utility is a measure of the level of happiness or satisfaction that someone receives from the consumption of a good  2. What is the difference between Total Utility and Marginal Utility?  Total utility is the overall satisfaction that is derived from the consumption of all units of a good over a given time period Marginal utility is the additional utility derived from the consumption of one more unit of a particular good. So, if someone gets ten units of satisfaction from consuming one piece of pizza and 15 units after consuming two pieces of pizza, then the marginal utility is five units 3. Explain the law of diminishing marginal utility Marginal utility is the additional utility that is derived from the consumption of one more unit of a good. The law of diminishing marginal utility suggests that as consumption of a good increases, the marginal utility will get smaller. 4. Question -1 The table below show’s the total utility that a consumer obtains from consuming a good 5. Explain the relationship between price and utility  One way to measure utility is to give the utility a monetary value.  For example, if I would pay £0.90 for a piece of cake, then we can say the utility is at least £0.90  In the above example, if a piece of cake cost £0.90, it would make sense to consume two pieces.  The first piece gives 120p of utility – which is greater than the price of 90p.  The second piece gives a utility equal to the price.  The third piece would give marginal utility of only 60p – which is less than the price of 90p 6. What is the optimum level of consumption  For one good, the optimum level of consumption would be to consume a quantity of the good unto the point where MU = Price.  There’s no point paying 75p for cake if it only gives us 50p worth of utility.  7. Explain Equi-marginal principle  individuals allocate their resources in such a way that the marginal utility (satisfaction or benefit) per unit of expenditure or effort is equal across all goods or activities  This principle is based on the observation that as individuals consume or allocate resources, the additional satisfaction or benefit gained from consuming one more unit of a good or engaging in one more activity tends to decrease over time.  Therefore, to maximize overall utility, individuals should allocate their resources in a way that the marginal utility-to-price ratio is equal for all goods.  Mathematically, the equimarginal principle can be expressed as follows: MU1 / P1 = MU2 / P2 = MU3 / P3 =... = MUn / Pn  The equimarginal principle states that by keeping other things constant, if a consumer spends his income on different commodities, he or she will get maximum satisfaction when marginal utility per unit of money is the same for each commodity.This principle is also known as the law of substitution or the law of maximum satisfaction.  This principle is used to find consumer equilibrium when a consumer consumes multiple commodities. 8. equi-marginal principle is based on the following assumptions: consumers have limited incomes consumers will always behave in a rational manner consumers seek to maximise their utility 9. example of how equi marginal utility is calculated  The above table shows the two goods produced and their prices. Two products, x and y, are priced at $1 and $2 respectively.  It is assumed that a consumer has $10 to spend.  Consumer equilibrium is where the MU/P is the same for each product.  This is where 4x and 3y are consumed  with a total utility score of 235. (60+40+25+12 = 137) + (42+ 32+24 =98 )  10. Application of the Marginal Utility Principle Case 1: When MU of A/Price of A > MU of B/Price of B In this situation, the consumer is not in equilibrium. The consumer is getting a higher MU from the last $ spent on good A than from good B. So, the consumer will reallocate his spending by increasing the quantity of good A and decreasing the quantity of good B. In this way, consumer equilibrium will be achieved. Case 2: When MU of A/Price of A = MU of B/Price of B In this situation, the consumer is in equilibrium, and there is no tendency to change that state. The consumer is getting the same MU from the last $ spent on good A and on good B. So, the consumer is getting the maximum TU. Case 3: When MU of A/Price of A < MU of B/Price of B In this situation, the consumer is not in equilibrium. The consumer is getting a higher MU from the last $ spent on good B than from good A. So, the consumer will reallocate his spending by increasing the quantity of good B and decreasing the quantity of good A. In this way, consumer equilibrium will be achieved.  11. Explain how an individual demand curve is derived  an individual demand curve is derived from the concept of marginal utility by analyzing how a consumer's willingness to purchase a good changes as its price changes.  The curve illustrates the inverse relationship between price and quantity demanded, and it reflects the consumer's preferences and the diminishing marginal utility associated with consuming more units of the good.  12. Explain the limitations of marginal utility theory and its assumptions of rational behaviour 1) utility is not something that can be measured; there is no objective way of valuing utility because this will vary from individual to individual 2) It is also difficult to imagine how the marginal utility approach would work when the analysis needs to be extended to multiple goods and services, so that the many interactions between the demand for one good and the demand for another need to be taken into account. 3) Marginal utility theory rests on the crucial assumption that consumers act rationally in taking decisions about their spending and consumption by setting out to maximise their utility. Recent advances in behavioural economics suggest that this is not always the case 4) People do not always focus on purely economic influences, but may act on impulse, or in response to their feelings. This can lead them to take decisions about their spending that cannot be explained only by utility maximisation. 5) enjoyment increases as consumption increases 6) quality and consistency of successive units of a good consumed may not be identical 7) cannot assume other things remain constant as overtime incomes and quality of goods may change 13. MCQ