Economics 2013-14


Consumers get satisfaction from goods and services.

In economics this is called UTILITY.

Three ways to measure utility are:



How people react when consuming
How much of the product they consume
The price they are willing to pay.


Total utility is the total satisfaction a consumer will get from consuming a product over a period of time.

Marginal utility is the satisfaction gained from consuming an extra unit of a product.

Total utility is the total of the marginal utilities gained from each unit consumed.


As someone consumes more of a product the utility gained from each extra unit decreases.

Total utility will continue to increase but at a slower rate, until a maximum is reached.

At this point there is no more satisfaction to be gained from consuming more of the product. Marginal utility will be zero.

PINT OF BEER MARGINAL
UTILITY
First £2.00s worth
TOTAL UTILITY
£2.00s worth
Second
Third
Fourth
£1.80s worth
£1.50s worth
£1.10s worth
£3.80s worth
£5.30s worth
£6.40s worth


If price was £2.00 the consumer would be willing to buy 1 pint because he gets £2 worth of satisfaction.

If the price was £1.80 he would be willing to buy 2
pints. He gets £2 worth of utility from the first pint and £1.80’s worth from the second.


The information can be shown as a demand
schedule.

This shows how much a consumer would be willing to buy at a range of prices.
Price Quantity
Demanded
£2.00
1
£1.80
£1.50
£1.10
2
3
4


This is the difference between how much a consumer would be prepared to pay and what is actually paid.

If the price of beer was £1.80 a pint, the consumer would buy 2 pints. He was prepared to pay £2 for the first pint so he gets 20p of utility free, a consumer surplus of 20p


Economists believe that consumers act in a rational way.

This means they want the best value for money.

Not always possible due to:
 imperfect knowledge


Action of other people
Lack of self-control.


Assuming rational behaviour, a consumer will achieve maximum utility when the marginal utility spent on the last unit of each good is equal

This is called EQUI-MARGINAL RETURNS


Demand (or effective demand) is the quantity of a good or service which a consumer is ABLE and WILLING to buy at a particular price over a certain period of time.

Two types of demand exist:
1.
INDIVIDUAL DEMAND – this is demand of one person for a product.
2.
MARKET DEMAND – this is all the individual demand added together.


The Law of Demand states:

 that as the price of a product increases the demand for it will fall.
This happens for two reasons:
1.
2.
INCOME EFFECT – as the price of a product increases then a person’s real income falls. They are not ABLE to buy the same amount.
SUBSTIUTION EFFECT – as the price of a product increases people will swap to goods that are close to the original product. They are less WILLING to buy.


The demand curve slopes downward from left to right.

It shows that as price increases the quantity demand falls and vice versa.

PRICE
D
P1
P
TYPICAL
DEMAND CURVE
Q1 Q
D
QUANTITY

These are goods or services where demand rises as price increases.

Goods of prestige, e.g. designer goods

Assumption of a link between price and quality – higher the price the better the quality.

Expectation of future price rises, e.g. buying shares.

Giffen goods – highly inferior goods, e.g. rice and potatoes.

PRICE
EXCEPTIONS DEMAND
CURVE
QUANTITY


The demand curve for the exceptions to the Law of
Demand will slope upwards to begin with.

Eventually though it will resume the normal shape as the income effect kicks in.


IT IS IMPORTANT TO REMEMBER THAT WHEN IT IS PRICE THAT
CHANGES IT IS A MOVEMENT ALONG THE DEMAND CURVE.

INCREASE IN PRICE IS A CONTRACTION IN DEMAND.

DECREASE IN PRICE IS AN EXTENSION IN DEMAND.

DEMAND IS SAID TO HAVE RISEN BUT NEVER INCREASED!

CETERIS PARIBUS - This is Latin for other things remaining the
same. It means that in Economics there is only ever one changing variable at a time.

Price is only one factor that might change the demand of a product, in reality there are many other factors.


Disposable Income
 demand for normal goods/inferior goods

Other goods

 price goes up for one/effect on another e.g. Tea/Coffee
Effects on complimentary goods e.g. strawberries and cream

Population

Changes effects demand e.g. age

Tastes and preferences
 fashionable goods; advertising campaign effects


When it is a condition of demand, the demand curve will either shift to the left (decrease in demand) or shift to the right (increase in demand).

REMEMBER CETERIS PARIBUS. If it is a condition of demand price stays the same.


Two types exist:

Price elasticity

Income elasticity


This measures how responsive demand is to a change in price.

Measures how consumers react to the change of the price of a product.

FORMULA:

PED = % change in demand
% change in price


If PED is greater than 1, demand is very responsive to a change in price. Demand is PRICE ELASTIC

If the PED is less than 1, demand is not responsive to a change in price. Demand is PRICE INELASTIC.

If PED is 0, demand hasn’t changed, then demand is PERFECTLY
INELASTIC.

If PED is equal to infinity, demand has changed without a change in price, the demand is PERFECT ELASTIC.

If PED is equal to 1, then demand has UNITARY ELASTICITY.


Firms really need to know about the elasticity of demand as it helps determine whether they should increase or decrease its prices.

Government need to know about it to determine whether to increase or decrease taxation.


When demand is price elastic it would be better for the firm to decrease the price.

Elastic demand means that even when there is a small change in price there is a big change in demand.

If the firm was to increase the price the revenue gained from the increase in price would be less than the revenue lost as a result of the drop in demand.

P1
D
P
Revenue Gain
D
Revenue Loss
Q1 Q


In this situation the firm would increase the price.

Inelastic demand means that even when there is a big change in price there is only a small change in demand.

The revenue lost from the small change in demand is outweighed by the revenue gained from the change in price. So total revenue will increase.

P
P1
D
Revenue Gain
D
Revenue Loss
Q1 Q


Availability of substitutes – a product with a lot of substitutes will have elastic demand e.g. Nescafe.

Price relative to total spending – e.g. matches

Habit – any product that a consumer considers to be a necessity, then demand will be price inelastic. e.g. Petrol

Fashion – goods which are highly fashionable would be price inelastic e.g. IPhone

Frequency of purchase – products bought regularly would have price inelastic demand e.g. Milk


This measures the responsiveness of demand to changes in income.

FORMULA:

IED = % change in demand
% change in income


When a person’s income increases by 10% it does not mean that they will buy 10% more than before.

Some commodities will still be unaffordable – 0 income elasticity

Some products they will be no more or no less of e.g. newspaper – 0 income elasticity

Some products they may only buy a little more of, e.g. food.
These have income inelastic demand.

Some goods and services they will buy a lot more of, e.g. nights out. These have income elastic demand.


Both income elastic and income inelastic demand are said to have POSTIVE INCOME ELASTICITY

Some products the consumer will buy less of, inferiors goods such as own brands. These have NEGATIVE
INCOME ELASTICITY.


If a seller knows the income elasticity of their products they can predict what would happen to their products if incomes changed and how this would affect their revenue.

Also helps the government predict changes in revenue from taxes on products.