Lecfigtp 06

MarginalUtilityTheory
Utilityandconsumersatisfaction
Demand and the Consumer
Totalandmarginalutility
diminishingmarginalutility
Theoptimumlevelofconsumption
consumersurplus
marginalconsumersurplus totalconsumersurplus consumersurplusandthemarginalutilitycurve
QKathyeatsfiveslicesofpizzaoneeveningbut admitsthateachsliceofpizzadoesn'ttasteasgood asthepreviousone.ThissuggeststhatforKathy

A. B. C. TheTUfrompizzasispastits maximumpoint. TheMUofasliceofpizzais negative. TheMUisstillrisingbutby smalleramounts.
MU, P (pence per litre)
Tinasmarginalutilityfrompetrol
120 110 100 90 80 70 60 50 40 0 250 500 750 1000
D. TheMUispositivebut declining. E. TheTUispositivebut declining.
Q (litres per annum)
Tinasmarginalutilityfrompetrol
120 110
a
MU, P (pence per litre)
100 90 80 70 60 50 40 0 250 500 750 1000
Consumer surplus
b c MU
Utilityandconsumersatisfaction Totalandmarginalutility
consumersurplus
rationalconsumerbehaviour
Q (litres per annum)
Consumersurplus
Utilityandconsumersatisfaction Totalandmarginalutility
MU, P
consumersurplus
P1
MU
rationalconsumerbehaviour
maximisingconsumersurplus:P=MU O Q1
Consumersurplus
MU, P MU, P
Consumersurplus
P1
P1
Total consumer surplus
Total consumer expenditure

O Q1
MU
Total consumer expenditure

O Q1
MU
QRationalconsumerbehaviouriswhereaperson consumestheamountofagoodthat
A. B. C. maximisesthetotalutilityfrom thegood. maximisestheconsumersurplus fromthegood. minimisestheamountspenton thegoodtoachieveagivenlevel ofutility. maximisesthemarginalutility fromthegood. equatesthemarginalutilitywith thatfromothergoods.
Marginalutilityandthedemandcurve
anindividualsdemandcurve
D. E.
Derivinganindividualpersonsdemandcurve
MU, P MU, P
P1
Consumption at Q1 where P1 = MU
P1 P2
MU = D
MU = D
Q1
Q1
Q2
MU, P
a
anindividualsdemandcurve themarketdemandcurve
P1 P2 P3
b c
MU = D
Q1
Q2
Q3
theshapeofthedemandcurve
theshapeofthedemandcurve shiftsinthedemandcurve
Limitationsoftheonecommodityversion
marginalutilityaffectedbyconsumptionofother goods
Risk,UncertaintyandInsurance
Demandunderconditionsofriskanduncertainty
theproblemofimperfectinformation
Attitudestowardsriskanduncertainty
definingriskanduncertainty typesofodds riskattitudes
riskneutral riskloving riskaverse
marginalutilityaffectedbyconsumptionofother goods marginalutilityofmoneynotconstant
QIfabusinesspersoniswillingtoincurcostsuptoa maximumof1monabusinessventurethathasa50:50 chanceofearningrevenueof800,000or1.3million, thenthatpersoncouldbedescribedas
Diminishingmarginalutilityofincomeand attitudestowardsrisktaking
mostpeopleareriskaverse diminishingmarginalutilityofincomes
A. riskloving B. riskneutral C. riskaverse
Totalutilityofincome
TU
U2 Total utility Total utility
Diminishing marginal utility of income
TU
b
U1
U1
5000
10 000
15 000
5000
10 000
15 000
Income ()
Income ()
c b Total utility
TU
U3 U2 U4 U1 a b d c
TU
U3 U2 Total utility
U1
U4 = (U1 + U3)
10 000 is preferable to a 50:50 chance of either 5000 or 15 000
5000
10 000
15 000
5000
8000 10 000
15 000
Income ()
Income ()
Insurance:awayofremovingrisks
howinsurersspreadrisks
thelawoflargenumbers
QWhichofthefollowingwouldNOThelpan insurancecompanyreducetheproblemofmoral hazardforcartheftinsurance?

A. B. C. Anoclaimsbonus. Lowerpremiumsforthosewith caralarms. Anexcesssystem,wherebythe claimanthastopaythefirstso muchofaclaim.
importanceoftheindependenceofrisks
problemsforinsurers
adverseselection moralhazard
D. Higherpremiumsforthoseliving inareaswherecartheftismore common.
QWhichofthefollowingwouldNOThelpan insurancecompanyreducetheproblemofadverse selectioninhealthinsurance?

A. B. C. Higherpremiumsforolderpeople. Medicalchecksbeforeinsuranceis granted. Reducingpayoutforaccidentscaused bycarelessness.
NextPortionisOptional
D. Checkingwhetherinsurancehasbeen refusedbyanyotherinsurance company.
Thecharacteristicsoftwobrandsofbreakfastcereal
TheCharacteristicsApproach
Consumerchoicebetweenproducts
importanceofproducts'characteristics
Quantity of fibre
Healthbran
Identifying&plottingcharacteristics
plottingaproduct'smixofcharacteristics
Tastyflakes
f1 f3
h1 t1
s1
s3
Quantity of sugar
Quantity of fibre
Healthbran
plottingaproduct'smixofcharacteristics changesinaproduct'scharacteristics
Tastyflakes
f1 f3
h1 t1
s1
s3
Quantity of sugar
Thebudgetconstraint
Thebudgetconstraint
affectshowmuchofeachcharacteristiccanbe purchased
Healthbran
Tastyflakes
Quantity of fibre
f1 f3
h1 t1
Thebudgetconstraint
effectsofachangeinthebudget
s1
s3
Quantity of sugar
Healthbran
Tastyflakes
Quantity of fibre
f2
h2
f1 f3
h1 t1
Thebudgetconstraint
effectsofachangeinthebudget effectsofchangeinaproduct'sprice
s1
s2
s3
Quantity of sugar
Healthbran
Theefficiencyfrontier
showsthedifferentcombinationsof characteristicsthatcanbepurchased
Quantity of fibre
f2
h2
Tastyflakes
f1 f3
h1 t1
s1
s2
s3
Quantity of sugar
Healthbran Assume a given budget and that this is the maximum amount of Healthbran that can be afforded for this budget (assuming no Tastyflakes are purchased) f1 f3 f2
Theefficiencyfrontier:fourbrands
Healthbran Oatybix
a
Quantity of fibre
Quantity of fibre
a c
Tastyflakes
Tastyflakes
The efficiency frontier

b
Alternatively, for the same budget, assume that this amount of Tastyflakes could be purchased (assuming no Healthbran is purchased)
c
Sweetreats
s1
s3
s Quantity of sugar
2
O Quantity of sugar
Consumingamixtureoftwoproducts
interpretingapointonthefrontier
Quantity of fibre
Healthbran
a c d e b
Tastyflakes
fall fh ft
sh
st
sall
Quantity of sugar
Quantity of characteristic A
QInthediagram,ifbrandX becamemoreexpensive,the efficiencyfrontierwould?

A. B. C. D. E. F. Shiftoutwardsparallel toitsoriginalposition. Shiftinwardsparallel toitsoriginalposition. Becomesteeper,passingthrough pointy1. Becomeflatter,passingthrough pointy1. Becomesteeper,passingthrough pointx1. Becomeflatter,passingthrough pointx1.
The characteristics of two brands of a good

Brand X
x1
Original efficiency frontier
Brand Y
y1
Quantity of characteristic B
causesofshiftsinthefrontier
casesofshiftsinthefrontier
indifferencecurves
Choosingbetweenbrands
indifferencecurves
plottingindifferencecurves
I5 I2 I4 I3
I1 Quantity of characteristic B
indifferencecurves
plottingindifferencecurves theshapeofthecurves
I2
I3
I5 I4
showsthedifferentcombinationsofcharacteristics thatcanbepurchased
showsthedifferentcombinationsofcharacteristics thatcanbepurchased
indifferencecurves
indifferencecurves
theoptimumconsumptionpoint
thetangencypoint
theoptimumconsumptionpoint
Brand 1 Quantity of characteristic A Brand 2 Quantities of any one of three brands that can be purchased for a given budget at current prices. Brand 2 is chosen Brand 3
Choosingamixtureofbrands
Brand 1 Quantity of characteristic A
a b
a b e c
Brand 2
c
I2 I3
I5 I4
I2
I3
I5 I4
changesinaproduct'sprice
movementalongtheproduct'sray
Brand 1 Brand 2
Responsetovariouschanges
Fall in price of brand 1. d Brand 1 is now chosen a b

Brand 3
c
I2
I5 I4 I3
movementalongtheproduct'sray relationshiptocrosspriceelasticityofdemand
changesinincome
Choosingamixtureofbrands
Brand 1
d
Rise in income
a b e c
Brand 2
changesinincome
parallelmovementofefficiencyfrontier
I5 I2 I4 I3
changesinincome
changesinincome
changesinaproduct'scharacteristics
changeinslopeofproduct'sray
AchangeinthecharacteristicsofBrand1
Brand 1 (before) Brand 1 (after) Brand 1 is now chosen
Characteristics of Brand 1 change Brand 2
changesinincome
I2 I1
changeinslopeofproduct'sray movementalongnewray
Brand 2 is chosen
Quantity of characteristic B
changesinincome
changesinincome
changesintastes
shiftinindifferencecurves
changesintastes
QAchangeinincomewouldbeillustratedby
A. aparallelshiftinthe indifferencecurves. B. aparallelshiftintheefficiency frontier. C. achangeintheshapeofthe indifferencecurves. D. achangeintheslopeofthe efficiencyfrontier. E. achangeintheslopeofthe productsray.
QAchangeinthepriceofaproductwouldbe illustratedbya
A. B. C. parallelshiftinthe indifferencecurves. parallelshiftintheefficiency frontier. changeintheshapeofthe indifferencecurves.
D. changeintheslopeofthe efficiencyfrontier. E. changeintheslopeofthe productsray.
QAchangeintastesbetweencharacteristicswouldbe illustratedbya
A. B. C. parallelshiftinthe indifferencecurves. parallelshiftintheefficiency frontier. changeintheshapeofthe indifferencecurves. A. B. C.
QAchangeinaproductscharacteristicswouldbe illustratedbya
parallelshiftinthe indifferencecurves. parallelshiftintheefficiency frontier. changeintheshapeofthe indifferencecurves.
OptionsopentothefirmproducingBrand1
Brand 1
Usefulnessofcharacteristicsapproach
helpsunderstandthenatureofconsumerchoice helpsfirmsinunderstandingtheeffectsofmaking changes
toconsumerperceptions
throughchangingproductspecifications bypromotingvariouscharacteristicsthroughadvertising
e d
Effect of lowering prices, or advertising
Brand 2
Brand 3
c
I5 I2 I4 I3
repositioningitsproduct
Usefulnessofcharacteristicsapproach
helpsunderstandthenatureofconsumerchoice helpsfirmsinunderstandingtheeffectsofmaking changes
toconsumerperceptions
throughchangingproductspecifications bypromotingvariouscharacteristicsthroughadvertising
Limitationsofcharacteristicsapproach
probleminmeasuringcharacteristics mostproductshavemanycharacteristics
onlytwocharacteristicscanbeplotted
probleminidentifyingindifferencecurves
hardforoneindividual moredifficultforwholemarkets
butcandividemarketsintosegments
repositioningitsproduct launchinganewbrand
consumertasteschange

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MarginalUtilityTheory

Demand and the Consumer

QKathyeatsfiveslicesofpizzaoneeveningbut admitsthateachsliceofpizzadoesn'ttasteasgood asthepreviousone.ThissuggeststhatforKathy

D. TheMUispositivebut declining. E. TheTUispositivebut declining.

Q (litres per annum)

MU, P (pence per litre)

100 90 80 70 60 50 40 0 250 500 750 1000

Total consumer surplus

Total consumer expenditure

Total consumer expenditure

QIfabusinesspersoniswillingtoincurcostsuptoa maximumof1monabusinessventurethathasa50:50 chanceofearningrevenueof800,000or1.3million, thenthatpersoncouldbedescribedas

A. riskloving B. riskneutral C. riskaverse

10 000 is preferable to a 50:50 chance of either 5000 or 15 000

QWhichofthefollowingwouldNOThelpan insurancecompanyreducetheproblemofmoral hazardforcartheftinsurance?

D. Higherpremiumsforthoseliving inareaswherecartheftismore common.

QWhichofthefollowingwouldNOThelpan insurancecompanyreducetheproblemofadverse selectioninhealthinsurance?

D. Checkingwhetherinsurancehasbeen refusedbyanyotherinsurance company.

The efficiency frontier

QInthediagram,ifbrandX becamemoreexpensive,the efficiencyfrontierwould?

The characteristics of two brands of a good

Original efficiency frontier

Fall in price of brand 1. d Brand 1 is now chosen a b

Characteristics of Brand 1 change Brand 2

D. changeintheslopeofthe efficiencyfrontier. E. changeintheslopeofthe productsray.

D. changeintheslopeofthe efficiencyfrontier. E. changeintheslopeofthe productsray.

D. changeintheslopeofthe efficiencyfrontier. E. changeintheslopeofthe productsray.

Effect of lowering prices, or advertising

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