Module 4

Question 1

Define rational consumer:

Answer 1

A person who weighs up the costs and benefits of each additional unit purchased to themselves.

Question 2

Define marginal utility:

Answer 2

Additional satisfaction derived from consuming one extra unit of a good within a given time period.
Assumes consumption of other goods are constant.

Question 3

Define ‘diminishing marginal utility’

Answer 3

When additional utility gained from consuming successive units of a good will decrease.

Question 4

Explain and illustrate relationship between total utility and marginal utility curves for risk-averse individual.

Answer 4

Refer to notes. Card M4-02
Marginal utility = gradient of total utility curve and so is positive and decreasing. (Increases but by less per unit each time)

Question 5

Three reasons why someone’s marginal utility schedule might change (for a particular good):

Answer 5

Due to changes in their:
1. Consumption of other goods, especially changes in complements and substitutes.
2. Tastes e.g. if they decided to lose weight/eat more healthy
3. Other circumstances e.g. amount of leisure time available.

Question 6

Descibe the water-diamond paradox?

Answer 6

• Total utility derived from water is very high, but marginal utility is low.
• Because; water is in high supply, so we can consume nearly as much water as we want.
• Very low supply of diamonds, so even if demand for diamonds are lower than water, price of diamonds still higher.
• Total utility of diamond is much lower than water since we consume so few diamonds.
• Marginal utility of diamonds > Marginal utility of water.
• Marginal utility NOT Total utility which determines the price.
• Higher MU of diamonds is associated with higher price of diamonds.

Question 7

Difference between ‘marginal consumer surplus’ and ‘total consumer surplus’
Illustrate total consumer surplus.

Answer 7

MCS = excess utility gained over and above the price paid for an additional unit of good.
MCS = MU - P

TCS = Total excess of what the person would have paid over what they actually paid for the good. (How much person is willing to over pay).
TCS = TU - TE
Total consumer surplus = total utility gained - total expenditure.

Graph - Refer to notes. Card M4-05

Question 8

How is consumer surplus realted to rational consumer behaviour?
How to derive downward sloping demand curve according to one-commodity model?

Answer 8

• Rational consumer behaviour attempts to maximise total consumer surplus (utility gained > equal expenditure)
• If MU of good in terms of price > price paid for that good then consumer should buy more.
• Consumer surplus is maximised when marginal utility of good = price paid for that good. (People should consume good to point where MU = P)

cont.