UTILITY

CHAPTER 30
 ECONOMICS IN CONTEXT

 Publicity from the US appears to have led to an increasing number of retailers joining in the event.
 Consumers: money-saving offers are an opportunity to buy things that they have been saving for; they could be tempted
into buying things they do not need or cannot afford. Retailers: can get rid of unsold stock, especially seasonal stock;
clears space in stores for Christmas items; opportunity to generate a cash-flow. Manufacturers: sell off old stock of last
year’s models, especially electronic goods; promote products which might be bought later by consumers.
 In France: Consumers may feel that they are losing out on the chance of a bargain. Long-term ban may lead to a more
even sale of goods – this is likely to be beneficial for manufacturers and retailers.
 30.1 Utility and diminishing marginal utility

 Utility: a measure of the level of happiness or satisfaction that someone receives from the consumption of a
good.
 Utility assumes that satisfaction can be measured in units, in the same way that the actual goods consumed can
be determined.
 Example: Suppose you were hungry and wanted a slice of pizza. How much would you pay for it?
o $2 for 1st slice > $1.50 for the 2nd slice > $1.25 for the 3rd slice > ….
o Because the satisfaction or utility you derived from consuming a further piece of pizza has decreased as your
consumption increases.
o The reduced amount you have paid for each successive piece of pizza is indicative of the reduced satisfaction you
have received from consumption.
 30.1 Utility and diminishing marginal utility

 Marginal utility: 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.
 Two important measures of satisfaction are:
• Total utility – the overall satisfaction that is derived from the consumption of all units of a good over a given time period
• Marginal utility – 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.
 When marginal utility becomes zero, the consumer will not derive any more satisfaction by increasing consumption of that
good. Total utility is therefore maximised at this point.
 30.1 Utility and diminishing marginal utility

 The law of diminishing marginal utility can also be applied to a situation where a consumer sees an item on
sale at a price less than expected. The consumer is likely to buy the item. By contrast, if an item is priced at more
than the expected price, a consumer will be unlikely to buy the item at this time. Both consumers are linking the
item’s utility with the actual price at the point of sale.

 The margin and decision-making: Utility may be used to consider how consumers rank their purchases in relation
to the satisfaction that is gained from their consumption.

*ACTIVITY 30.1
 Activity 30.1

 1. Marginal utility 7, 4, 3, 2, 1, 1
 2.

 3. Revision that takes place closest to the examination is likely to be most productive.
 30.2 The equi-marginal principle

 According to equi-marginal principle, the consumers will maximise their utility where their marginal valuation for
each product consumed is the same.
 The equi-marginal principle states that consumers will choose a combination of goods to maximise their total utility.
 Formula:

𝑴𝑼 𝑨 𝑴𝑼 𝑩 𝑴𝑼 𝑪 𝑴𝑼 𝑵
= = =…= = 𝑴𝑼 𝒎
𝑷 𝑨 utility 𝑷 𝑩
Where: MU = marginal
𝑷𝑪 𝑷𝑵
P = Price
A, B, C and N = different products
= Marginal utility of money
 30.2 The equi-marginal principle

 Equi-marginal principle is based on the following assumptions:

 Equilibrium and disequilibrium: The equi-marginal principle is used to determine whether or not consumer equilibrium is
being achieved.
 30.2 The equi-marginal principle

 Example: 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. No other combination of goods generates a higher total utility; therefore, any other combination would
provide less satisfaction.
 30.3 Derivation of an individual demand curve

 Marginal utility can be used to explain how an individual’s demand curve is derived.

 Example work: Assume the price of y is now reduced to $1; the price of x and the income remain unchanged.
1. Re-calculate the new MU/P for product y.
2. Find the new consumer equilibrium.
3. Did total utility increased?
4. Calculate the increase in total utility.
 30.3 Derivation of an individual demand curve

 Answers:
 1. New MU/P = 42, 32, 24, 18, 14, 12
 2. The new equilibrium is 4x and 6y.
 3. Yes
 4. Increase by 44

 * How would you derive a more

 Marginal utility theory assumes that consumers are capable of putting their wants in rank order and assigning a value
to the satisfaction gained from their consumption.
 The law of diminishing marginal utility further assumes that consumers act and behave in a rational way in their
purchasing decisions.
 Empirical or real world evidence consistently shows that there are other factors (behavioural factors/ psychological
influences/ etc.) apart from utility that determine what we purchase.

 You should not assume that consumers always act in the way that is indicated by economic theory
 THINK LIKE AN ECONOMIST

 An increase in the sales of tinned food will increase employment in this branch of the food processing industry, both in
the UK and elsewhere.
 Going back down the supply chain, employment should increase among certain types of food producer and
manufacturers of tin containers. There could be a negative impact on other food producers, both in the UK and elsewhere
in countries that supply the UK with fresh food. The net effect is difficult to determine. Much will depend on whether the
increase in sales of tinned food is sustained.
Exercises

 Activity 30.2
 EXAM-STYLE QUESTIONS: MULTIPLE CHOICE
(Answer: D, B, D)