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UTILITY and DEMAND
UTILITY
• Utility is satisfaction.
• We get utility from the consumption of goods and services.
• We aim to maximise our total utility.
MARGINAL UTILITY
• Marginal utility is the extra utility we get from consuming one extra unit of a product.
• The law of diminishing marginal utility states that, at some point, our MU will fall as we consume more.
MU$
units
Total Utility and Marginal Utility
TU
MU
$ $
q1 q1
When TU is maximumMU = 0
OPTIMAL PURCHASE RULE
• A consumer will consume to the point where P = MU.
• If P>MU the consumer will not buy as it is too expensive.
• If P < MU the consumer will buy more.
CONSUMER EQUILIBRIUM
• If MU/P for one product equals MU/P for another product the consumer is in equilibrium. They will not change their spending pattern. They have maximised their total utility.
If MU/P for product A is greater than the
MU/P for product B the consumer will buy
more of A and less of B until MU/P is equal for
both products.
PARADOX OF VALUE
• It seems puzzling that water, which is essential for life, has a low value, whereas diamonds, which are not essential have a very high value.
Because we consume water in such large
quantities, the MU is low.
Diamonds however are consumed in small
amounts and so have a very high MU.
DEMAND
• Using P=MU and a consumers MU curve we can derive their demand.
Mu
$
unit
muQ
P
$
D
LAW OF DEMAND
• As price increases quantity demanded falls and vice versa (other factors being equal). As price increases MU/P falls, so we buy less. If we are consuming at P=MU and price rises then P>MU so we buy less until P=MU.
LAW OF DEMAND
P
$
QD
As price decreases then quantity demanded increases or as price increases quantity
demanded decreases other factors being equal.
Market Demand
PP
P P
Q QQ Q
+ +
dd d
d
Market demand is the horizontal summation of all the individual demand for a product. It is Qd1 + Qd2 + Qd3 at each price
INCREASE IN DEMAND
• A change in one of those “other factors” may cause an increase in demand. Like:
• Increase in income
• Change in tastes
• Increase in price of a substitute.
• Decrease in price of a complement
P
$
QD
D’
SUBSTITUTES
• Substitutes are products that we can use instead of each other. If the price of one rises, the quantity demanded falls causing an increase in demand for the other.
SUBSTITUTES
P P
Q Q
d
BUTTER MARGARINE
d’ d
Price of butter falls. Quantity demand for butter increases. Demand for margarine falls
COMPLEMENTS
• Complements are products that we usually use together.If the price of one rises, quantity demanded falls causing a decrease in the demand for the other.
COMPLEMENTS
CARS PETROL
P P
Q Qd dd”
Price of cars falls. Quantity demanded for cars increases. Demand for petrol increases.
NORMAL GOODS
• Are products that we demand more of when our income rises. Most products have this “normal” relationship.
INFERIOR GOODS
• Are products which we buy less of as our income rises. As our income increases we switch our spending towards higher quality products.
QUESTIONS
DESCRIBE
• The trend for total utility as a person consumes more and more of a product.
• The trend for marginal utility as a person consumes more and more of a product.
• The trend for quantity demand as price falls.• The trend for the consumption of an inferior good
as income increases.• The trend for the consumption of a normal good as
income increases.
EXPLAIN
• Why consumers increase their quantity demand as price falls.
Vocabulary
• Satisfaction from consumption of a good or service.
• As more of a good is consumed, the extra satisfaction decreases.
• The quantity a persons is able and willing to buy at a given price.
Vocabulary
• A consumer will purchase up to the point where MU=P
• A product used in place of another.
• A product often used in conjunction with another.