Chapter 8: Utility and Demand

Consumption possibilities

What influences our preferences?

•All the things that you can afford to buy
•is limited by your income and the prices of the goods you want


•Graphed using a budget line - marks the boundary between those combinations of goods+services a household can afford and those that it can't afford

Predictions of marginal utility theory

Consumption possibilities change when income or prices change.


• An increase in income shifts the budget line right but leaves its slope unchanged


•If the price of one good increases, budget line swivels inwards (left) (i.e you are buying less of both goods)
•If the price of one good decreases, budget line swivels outwards (right) (i.e you are buying more of both goods)




•A change in price changes the line's slope

Marginal utility: change in total utility that results from a one unit increase in the quantity of a good consumed
•+ve value, decreases as the quantity of a good consumed increases, known as diminishing marginal utility


MU = ▲TU ÷ ▲Quantity

Total utility: the total benefit that one gets from the consumption of all goods and services
•depends on the level of consumption - more consumption = more total utility
-as you consume more, the total utility will increase at a decreasing rate

Utility maximising choice
•Consumers will make the choice that maximises the utility they get from the good or service
•Calculated by finding the point on the budget line that gives the consumer that max attainable utility, i.e the point where the sum of utility of products is largest on the graph - the consumer equilibrium

•Consumer equilibrium is a situation where a consumer has exhausted all their income in a way that maximises their total utility


•Total utility can be maximised by:
•spending all available income - more consumption brings more utility, ∴ only choices that exhaust income maximise utility


•equalising the marginal utility per rand for ALL goods - as long as one good's MU is higher than the other's, MU is not maximised. Spend more on the good with a higher MU and less on the good with a lower MU
⚠ diminishing marginal utility, as you spend more on a good, its marginal utility decreases. As you spend less on the good with a lower MU, it’s marginal utility increases!

Marginal utility per rand calculation:


MU of good÷Price of good


•MU per rand is the MU from spending one more rand on a good
•By comparing this value, we can see whether a budget has been allocated to maximise total utility.

the MU theory predicts the law of demand

A decrease in price of product A

  1. Determine the just-affordable combinations of product A and B at the new prices
  1. Calculate the new marginal utilities per rand from the good whose price has changed
  1. Determine the quantities of product A and B that make their marginal utilities per rand equal

A rise in price of product A

A rise in income

•When the price of product A increases and the price of B and one's income remain the same, the Qd of product A decreases (i.e law of demand)

•Demand and consumption of product A and B increases (demand curve shifts right)

Behavioural economics:
•studies the ways in which limits on the human brains ability to compute and implement rational decisions influences economic behaviour. i.e the decisions that they make and the consequences for those decisions

Bounded willpower: willpower that prevents us from making a decision that we know we'll regret when we make it


e.g deciding to buy a cooldrink when you have already bought your cooldrink for the month at home just because you're thirsty now (sacrifice a chocolate bar at the end of month)

Bounded self interest: limited self interest that results in sometimes suppressing our own interests to help others


e.g if you sacrifice R10 for COVID-19 relief, you won't be able to maximise your utility for that month

Bounded rationality: rationality that is limited by human brain - we can't always work out the rational choice

Budget Line
•Budget line looks at an individual's limitations on choices of goods they can purchase, relative to their income and the prices of the goods


Eqn; good x and good y


Px.Qx + Py.Qy = Y(income)


To plot budget line with Qy on y-axis, make Qy subject of formula:


Py.Qy = Y-Px.Qx


Qy = Y/Py - Px/Py.Qx


Y÷Py = real income


Px/Py*Qx = relative price/opportunity cost


-Px÷Py = slope of the budget line (-ve curve)
Y÷Py = y-intercept of curve

⚠ Only one axis of budget line will swivel, while other axis remains the same. i.e If price of good y on Y-AXIS decreases, budget line will swivel outwards on Y-AXIS and x-axis will remain the same.


⚠ If price of good x on X-AXIS increases, budget line will swivel inwards on X-AXIS and y-axis will remain the same

If Y (income) increases -> Y/Py (real income) also increases
∴Y-intercept will move up (increasing)
∴curve shifts right, but slope remains the same (Px÷Py)


If Y (income) decreases -> Y/Py (real income) also decreases
∴ Y-intercept will move down (decreasing)
∴curve shifts left, but slope remains the same