Download Behind The Demand Curve I

Behind The Demand Curve I
► 1.Marginal




► 2.
utility theory
assumptions
law of diminishing marginal utility
optimal consumption
critique
Uses of utility theory?
Uses
► (i)
Elasticity - determined by preferences.
How quickly MU diminishes
► (ii)
Efficiency - consumer surplus.
Resource allocation
► (iii)
Paradox of value - diamonds & water
Assumptions
► Consumers
► Ceteris
paribus
► Cardinalist
► Utility
are rational
approach - utils
= satisfaction (preferences)
Measurement of utility
► Total
utility
 “… the total satisfaction gained from the
consumption of ALL units of a commodity.”
► Marginal
utility
 “…the extra utility derived from the
consumption of one more unit of a good, the
consumption of all other goods remaining
unchanged.”
► See
Figure 1-3 - shape & calculation
Utility from consuming cream cakes (daily)
16
TU
14
Utility (utils)
12
MU
No. of cream TU
cakes in utils in utils
10
0
1
2
3
4
5
6
8
6
4
7
4
2
1
0
-1
0
7
11
13
14
14
13
2
0
0
1
2
3
4
5
-2
No. of cream cakesfigconsumed (per day)
6
The Law of Diminishing Marginal Utility
► Slope
of the MU schedule
► Definition
 “…as the quantity of a good consumed by an
individual increases, the marginal utility of the
good will eventually decrease.”
► Marginal
analysis
Optimal consumption - background
► Consumers
have limited income. Choices.
No saving
► Rational consumer - maximise utility
► Measurement problem - utils?
► Solution: measure utility in money
 price prepared to pay
 price you actually pay
Optimal consumption - single good
► Buy
one extra unit when
 MU > Price
►MU
(in monetary terms) = marginal benefit
►Price = marginal cost
► Stop
when
 MU = Price
Optimal consumption - consumer
surplus(CS)
► Consumer
surplus
 Price prepared to pay - price actually paid
► Marginal
consumer surplus
 MCS = MU - marginal expenditure
 MCS = MU - P
► i.e. the excess of utility over price
► Buy
more when MU > P (MCS positive).
Stop MU = P
Derivation of the demand curve
► Equals
the MU curve as long as consumers
maximise CS
► If
price falls: buy more since MU > P or MCS
is positive
 movement along demand schedule
Marginal utility from petrol
120
110
MU, P (pence per litre)
a
100
Consumer
surplus
90
b
c
80
MU
70
60
50
40
0
250
500 fig
Q (litres per annum)
750
1000
Optimal consumption - multi-good case
► Equi-marginal
principle
 MUa \ Pa = MUb \ Pb = MUc \ Pc = … MUn \ Pn
 If price of a good changes - reallocate income
► If
income is fixed
 …utility is maximised when the utility from the
LAST pound spent on ALL goods is equal
Uses
► (i)
Elasticity - determined by preferences.
How quickly MU diminishes
► (ii)
Efficiency - consumer surplus.
Resource allocation
► (iii)
Paradox of value - diamonds & water