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1. Explain the concept of utility: total, marginal, cardinal (marginalist approach), ordinal (indifference
curve approach).
2. a) Explanation of diminishing marginal utility.
b) The main assumptions and limitations of Marginal Utility Theory.
3. Indifference curves and the budget constraint, (budget lines).
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In the real world, consumers seek to maximise their welfare, subject to the constraints imposed by their income
and the market prices of goods and services. Economists have long been interested in the way that consumers
behave. A good starting point is the notion of utility. This term is used to record the level of happiness or
satisfaction that an individual derives from the consumption of a good. It can therefore be said that a consumer
will only purchase a good or service if it offers him utility, (satisfaction). It is assumed that this satisfaction can
be measured or quantified.
Economists are concerned with
o total utility the overall satisfaction that is derived from the consumption of all units of a good over a
given period of time.
o marginal utility the additional utility derived from the consumption of one more unit of a particular
good.
If the consumer realises a total utility of from consuming units of a commodity, and from
consuming units of the same commodity then the marginal utility derived from consuming the nth
unit is given by the formula below.
The marginal utility gained from the consumption of a product tends to fall as consumption increases. For
example, on a hot day, after a double period of PE, you would probably get a high level of satisfaction from
eating a sno-cone. If you consume a second sno-cone, you will still get some satisfaction, but this is likely to be
less than from the first one. A third sno-cone will yield even less satisfaction. This aspect of consumer
behaviour is referred to as the law of diminishing marginal utility. There may actually come a point, (maybe
by the tenth sno-cone), where you are feeling uncomfortable and bloated, and you no longer experience any
Economics assumes that consumers have limited incomes, behave in a rational manner and seek to maximise
their total utility.
In a single commodity framework, a rational consumer will continue to demand a commodity up to the point
where the marginal utility derived from the last unit consumed is exactly equal to the price that the consumer
has to pay. If the marginal utility is greater than the price, the consumer can maximise total utility by purchasing
more of the good. A rational consumer would not pay more for a good than its marginal utility, so if the
marginal utility is less than the price, the consumer would purchase less of the good.
In a multi-good framework, the same principle can be applied. A consumer is said to be in equilibrium,
assuming a given level of income, when it is not possible to switch any expenditure from one product to another
in order to increase total utility. This is referred to as the equi-marginal principle, (or condition), and can be
represented by the equation
In the real world, economic agents make trade-offs between the goods they consume. Indifference curve
analysis can help to make these trade-offs clearer. The slope of the indifference curve illustrates that the
consumer will be willing to give up progressively fewer units of Good B for Good A if they wish to remain at
the same level of satisfaction, i.e. on the same indifference curve.
To quantify the amount of Good B that a consumer is willing to give up for Good A, economists calculate the
marginal rate of substitution, (MRS). The MRS of Good A for Good B can be described as the number of units
of Good A sacrificed for one unit of Good B. The MRS is therefore the slope of the indifference curve. It is
clear that the slope of the indifference curve falls continually.
All consumers are constrained in what they are able to buy because of their income and the prices of the goods
and services that they wish to buy. These two underpinning principles of consumer behaviour are brought
together in the idea of the budget line. This illustrates all the possible combinations of two products that a
consumer can purchase with a given income and fixed prices.
Summary Exercise
1. The table below shows the utility that Simone gets from the consumption of DVDs and Kindle books.
Simone has $100 per month to spend on DVDs and Kindle books. Both DVDs and Kindle books cost
$20 each.
Quantity Utility from DVDs Utility from Kindle books
0 0 0
1 30 30
2 40 38
3 48 44
4 54 46
5 58 47
2. Use the table below to draw an indifference curve to illustrate the different bundles of clothing and food
that give a consumer equal satisfaction.
Bundle Clothing Food
A 30 1
B 18 2
C 13 3
D 10 4
E 8 5
F 7 6