2. UTILITY and DEMAND

3. UTILITY Utility is satisfaction. We get utility from the consumption of goods and services. We aim to maximise our total utility.

4. 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. MUMU $ units

5. Total Utility and Marginal Utility TU MU $$ Q Q q1 When TU is maximum MU = 0

6. 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.

7. 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.

8. 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.

9. DEMAND Using P=MU and a consumers MU curve we can derive their demand. Mu $ unit mu Q P$P$ D

10. 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.

11. LAW OF DEMAND P$P$ Q D As price decreases then quantity demanded increases or as price increases quantity demanded decreases other factors being equal.

12. Market Demand P P P P QQQ Q ++ d d d d Market demand is the horizontal summation of all the individual demand for a product. It is Qd1 + Qd2 + Qd3 at each price

13. 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$P$ Q D D’

14. 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.

15. SUBSTITUTES P P Q Q d BUTTERMARGARINE d’ d Price of butter falls. Quantity demand for butter increases. Demand for margarine falls

16. 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.

17. COMPLEMENTS CARS PETROL PP Q Q d d d” Price of cars falls. Quantity demanded for cars increases. Demand for petrol increases.

18. NORMAL GOODS Are products that we demand more of when our income rises. Most products have this “normal” relationship.

19. 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.

20. QUESTIONS

21. 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.

22. EXPLAIN Why consumers increase their quantity demand as price falls.

23. 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.

24. 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.