EC229, Economics of Strategy

Term 2/3, 2017/18

Worksheet 1

1. People generally buy goods and services because they expect to gain satisfaction from them. We
call this satisfaction utility. An important distinction we make is between total and marginal
utility.

(a) Total utility (TU) can be defined as...........................................................................................

(b) Marginal utility (MU) can be defined as....................................................................................

2. Total utility will fall whenever

A. Marginal utility is falling.

B. Marginal utility is rising.

C. Marginal utility has reached a maximum.

D. Marginal utility is zero.

E. Marginal utility is negative.

3. The following table below shows the total utility that Katie derives from visits to the cinema per week.
Visits 0 1 2 3 4 5 6 7 8
TU (utils) 0 12 20 25 28 30 31 31 29

MU (utils)

(a) Fill in the figures for marginal utility. (Note that the MU figures are entered mid-way
between the TU figures. This is because marginal utility is the extra utility of going from
one level of consumption to the next.)

(b) (See over)

 (b) Draw a graph of the figures for total and marginal utility on the figure below.

Katie’s utility from visits to the cinema

34
32
30
28
26
Total and Marginal Utility (in utils)

24
22
20
18
16
14
12
10
8
6
4
2
0
-2
-4
0 1 2 3 4 5 6 7 8
Weekly visits to the cinema

(c) Assume that Katie now befriends somebody who also likes going to the cinema. As a result
her marginal utility for each visit doubles. What is her total utility now for:

(i) 3 visits? .............................................................................................................................

(ii) 6 visits?..............................................................................................................................

(iii) 7 visits?..............................................................................................................................

4. You will notice from the graph you have drawn above that the marginal utility curve slopes
downwards. This is in accordance with the principle of diminishing marginal utility. Which of
the following are directly related to the principle of diminishing marginal utility?
(a) Rather than eating one large savoury course at dinner, I prefer to have less first course
so as to leave room for a pudding..................................................................................Yes/No
(b) I prefer to spend my time playing sport rather than watching television......................Yes/No
(c) I like to watch a little television in the evenings............................................................Yes/No
(d) I like watching comedy programmes more than documentaries....................................Yes/No
(e) I get bored easily............................................................................................................Yes/No

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5. The following diagram shows the marginal utility (MU) that a consumer gets from consuming
different quantities of a product. Assume that the current market price of the product is P.

Marginal utility,
Price (£)

(1)
P

(2)
(3)
MU
Q Quantity purchased

(a) Why is the optimum consumption point at Q?.........................................................................

(b) What area(s) represent(s) total utility at Q?..............................................................................

(c) What area(s) represent(s) the consumer’s total expenditure at Q?............................................

(d) What area(s) represent(s) the consumer’s total consumer surplus at Q?...................................

6. How much of a good will people buy? If they wish to maximise their self-interest (what is
known as ‘rational’ behaviour), they will compare the marginal utility they expect to get from
consuming the good with the price they have to pay. This will involve perceiving marginal
utility in money terms (i.e. how much an extra unit of the good is worth to them).
The table below shows marginal utility a person gets from consuming different quantities of
a good. Assume that the good sells for £10.

Marginal utility for person Y from good X

Quantity Consumed 0 1 2 3 4 5 6

Marginal Utility (£s) 25 20 16 12 8 4

(a) What is the person’s total utility from consuming 4 units?.......................................................

(b) What is the person’s total expenditure from consuming 6 units?..............................................

(c) What is the person’s marginal consumer surplus from consuming a second unit?...................

(d) What is the person’s total consumer surplus from consuming 2 units?....................................

(e) At what level of consumption is the person’s total consumer surplus maximized?..................

(f) What is the relationship between price and marginal utility at this level?................................

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 Jamie’s total utility from his income
7. The figure opposite shows the total utility 800
that Jamie, a first-year degree student, 700
would get from different levels of annual
600
income. Assume at the moment that his
annual income (from an allowance from 500
his parents and some part-time work in a

Utils
400
burger bar) is £4000. Spending this 300
rationally gives him a total utility of 500
200
‘utils’.
Assume that he is offered the chance 100
to gamble the whole £4000 on the toss of 0
a coin at odds of 2:1 (i.e. if he wins, he TU
0 2000 4000 6000 8000
doubles his money; if he loses, he loses Income (£)
the lot).

(a) If he takes the gamble, what will be his utility this year if he wins?

(b) If he takes the gamble, what will be his utility this year if he loses?........................................

(c) What would be his average expected utility from the gamble?.................................................

(d) Why is it likely that he will not take the gamble, and thus be risk averse?...............................