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

$ $

QQ

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.