Utility
Learning intentions
- Define the meaning of total utility and marginal utility.
- Calculate total utility and marginal utility.
- Explain diminishing marginal utility.
- Explain the equi-marginal principle.
- Explain an individual’s demand curve.
- Evaluate the limitations of marginal utility and its assumptions of rational behaviour.
Key terms
Knowledge and understanding
To answer the questions in this chapter, you need to know and understand:
- what is meant by utility
- the meaning and calculation of total utility and marginal utility
- the law of diminishing marginal utility
- the significance of the equi-marginal principle
- how to derive an individual demand curve
- the limitations and assumptions of utility theory
Practice questions — Multiple choice
Choose the best answer for each question.
1. A consumer gets 10 units of satisfaction when consuming a pizza that costs $2 and 4 units of satisfaction when consuming an ice cream. Assuming the consumer is rational and is in equilibrium, what is the price of the ice cream?
Answer: B. $2.00
2. Which statement best defines marginal utility?
Answer: D. The additional satisfaction from consuming one more unit
3. A consumer’s total utility rises from 42 utils to 50 utils after consuming one more unit. What is the marginal utility of that unit?
Answer: A. 8 utils
4. According to the law of diminishing marginal utility, what normally happens as consumption of a good increases?
Answer: B. Marginal utility eventually falls
5. Which condition represents consumer equilibrium under the equi-marginal principle for two goods X and Y?
Answer: D. MUx/Px = MUy/Py
6. If MU per dollar from apples is greater than MU per dollar from oranges, what should a rational consumer do?
Answer: A. Buy more apples and fewer oranges
7. Why can diminishing marginal utility help explain a downward-sloping demand curve?
Answer: B. Additional units give less satisfaction, so consumers require a lower price to buy more
8. Which is a limitation of traditional marginal utility theory?
Answer: D. Utility cannot be measured objectively with precision
9. A consumer buys another unit even though its marginal utility is zero. What happens to total utility?
Answer: A. It remains unchanged
10. Which change is most likely to shift a consumer’s demand curve rather than cause a movement along it?
Answer: B. A change in the consumer’s tastes
11. During precautionary buying, why might demand for essential goods increase?
Answer: D. Consumers expect possible future shortages and buy extra stocks now
Analysis — Precautionary buying and utility
There have been many instances where panic buying has followed a natural disaster, such as a hurricane or a tsunami. People may stock instant noodles, rice, bottled water and other essentials.
Consumers may increase total utility by purchasing larger quantities of certain products. For goods with long shelf lives, buying in bulk may continue to provide utility because the products can be stored and used later. Examples may include toilet paper, cereals, pasta, rice and flour. During periods of heavy precautionary buying, retailers may limit the quantity that each customer can purchase.
Precautionary buying may also provide utility because consumers feel more secure when they have supplies available. However, the extra utility is subjective. Goods with short shelf lives may eventually create waste or disutility, and one consumer’s stockpiling may reduce the quantity available to others.
Question 6
Analyse how the demand curve for a product can be derived from marginal utility.
The PEELE structure below represents only one body paragraph of the full response. Read the completed Point, Explain, Example and Link, then complete only the Evaluation.
A downward-sloping demand curve can be derived from the law of diminishing marginal utility because the additional satisfaction gained from consuming extra units of a product falls as consumption increases.
When a consumer buys the first units of a product, marginal utility is relatively high. As more units are consumed, marginal utility falls. A rational consumer will therefore only be willing to purchase additional units if the price is lower, because the extra satisfaction gained from those additional units is smaller.
For example, a consumer may be willing to pay $5 for the first bottle of water because it gives high marginal utility. The second bottle may provide less additional satisfaction, so the consumer may only be willing to pay $3. A third bottle may provide even less marginal utility and may only be purchased at $1.
Therefore, as price falls, quantity demanded rises. This inverse relationship between price and quantity demanded produces a downward-sloping demand curve.
Counter the Point and Explain above. Identify a condition or real-world situation in which diminishing marginal utility would not lead the consumer to buy more only when price falls. Explain why this condition weakens the argument. For example, consider habit, addiction, status, imperfect information, or consumers who do not behave rationally.
Question 7
Explain how precautionary buying is likely to affect the demand for essential products.
The PEELE structure below represents only one body paragraph of the full response. Read the completed Point, Explain, Example and Link, then complete only the Evaluation.
Precautionary buying is likely to increase the demand for essential products because consumers want to hold extra stocks in case future supplies become unavailable.
When consumers expect shortages, natural disasters or other disruptions, they may decide to buy more than they normally would at each price. This represents an increase in demand rather than a movement along the existing demand curve.
For example, if consumers expect a storm or transport disruption, they may buy additional bottled water, rice, pasta or toilet paper even though the prices of these goods have not changed.
Therefore, precautionary buying shifts the demand curve for essential products to the right, increasing the quantity demanded at each possible price.
Counter the Point and Explain above. Identify a condition in which precautionary buying would not cause a large increase in demand for essentials. Explain why the original argument would be weaker in that situation. For example, consider confidence that supplies will remain available, limited income or storage, short shelf life, or retailer purchase limits.
Evaluation
PEELE Writing Practice
Read the completed Point, Explain, Example and Link for each question. The PEELE structure shown represents only one body paragraph of the full essay, not the entire essay response. Then complete only the Evaluation section of this paragraph. Your evaluation should act as a counter to the Point and Explain: identify a condition or real-world case where the argument may not hold true, then explain why.
Question 1
Assess the extent to which marginal utility can be used to provide an accurate representation of a consumer’s demand curve for a product.
Marginal utility can help explain the downward-sloping demand curve because, as a consumer buys more units of a product, the marginal utility gained from each additional unit is likely to fall.
According to the law of diminishing marginal utility, each additional unit consumed provides less extra satisfaction than the previous unit. A rational consumer will therefore only be willing to purchase additional units if the price falls. This creates an inverse relationship between price and quantity demanded.
For example, a consumer may receive high marginal utility from the first bottle of water because it satisfies an urgent want. A second bottle provides less additional satisfaction, and a third provides even less. The consumer may therefore only be willing to buy the third bottle at a lower price.
Therefore, diminishing marginal utility provides a theoretical explanation for why a consumer’s demand curve is normally downward sloping, with a lower price associated with a larger quantity demanded.
Counter the Point and Explain above. Give a condition or counterexample in which diminishing marginal utility would not accurately explain the consumer’s demand curve, and explain why. For example, the argument may be weaker when choices are driven by habit, addiction, status, advertising, changing preferences, or imperfect information rather than a careful comparison of marginal utility.
Question 2
Assess whether the equi-marginal principle has any relevance in determining how consumer equilibrium is achieved.
The equi-marginal principle is relevant because it explains how a rational consumer can allocate a limited income between different products in order to maximise total utility.
Consumer equilibrium is reached when the marginal utility gained from the last unit of currency spent on each product is equal. If one product provides greater marginal utility per dollar than another, the consumer can increase total utility by spending more on the product with the higher marginal utility per dollar and less on the other product.
For example, if apples provide 8 units of marginal utility per dollar while oranges provide only 5, a rational consumer should shift some spending from oranges to apples. As more apples are consumed, diminishing marginal utility reduces the additional satisfaction from apples until the marginal utility per dollar from both goods becomes equal.
Therefore, the equi-marginal principle provides a theoretical explanation of how consumers may allocate scarce income and reach a position where no reallocation of expenditure can increase total utility.
Counter the Point and Explain above. Identify a condition in which the equi-marginal principle would not accurately describe how the consumer reaches equilibrium, and explain why. For example, consumers may be unable to measure utility, may lack information, may buy impulsively or habitually, or may not compare marginal utility per unit of currency at all.