Download UTILITY and DEMAND

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.
M
U
$
units
Total Utility and Marginal Utility
$
When TU is maximum
$
MU = 0
TU
q1
Q
Q
q1
MU
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
$
P
unit
mu
$
D
Q
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
As price decreases then
quantity demanded
increases or as price
increases quantity
demanded decreases other
factors being equal.
P
$
D
Q
Market Demand
P
P
P
d
d
d
d
+
Q
P
+
Q
Q
Q
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
$
D’
D
Q
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
d
d’
Q
Q
BUTTER
d
MARGARINE
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
P
P
d
CARS
Q
d
d”
Q
PETROL
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.