Week 6-7 How Marginal Utility Works?

APPLIED ECONOMICS Economists utilize the concept of marginal utility

to gauge how satisfaction levels affect
PRINCIPLE #6: How people interact
consumer decisions. Economists have also
• Markets Are Usually A Good Way to identified a concept known as the law of
Organize Economic Activity diminishing marginal utility, which describes
• Firms and Households interact in how the first unit of consumption of a good or
marketplace where prices guide their service carries more utility than subsequent
decisions. units.

The Wealth of Nations (1776) – Adam Smith

• Households and firms acts as if “led by an
invisible hand” to promote general economic
well-being.
• Smith believes that each household and
firms maximize their economic well-being by
focusing on their self-interest.
• Their interactions determine the prices of
commodities.

Demand and Supply

Market - exists when there is an interaction
between buyers and seller.
Market Demand - is the actual or potential
demand for a product within a particular market.
It also refers to the willingness and ability of the
buyers to pay a sum of money for a particular
good or service.
(Not all people can buy even though they have
money for an item)
What is Marginal Utility?
Marginal utility quantifies the added satisfaction
that a consumer garners from consuming
additional units of goods or services. The
concept of marginal utility is used by economists
to determine how much of an item consumer are
willing to purchase. Positive marginal utility
occurs when the consumption of an additional
item increases the total utility, while negative
marginal utility occurs when the consumption of
an additional item decreases the total utility.
What is Diminishing Marginal Utility?
The Law of Diminishing Marginal Utility states
that all else equal as consumption increases the
marginal utility derived from each additional unit
declines. Marginal utility is derived as the
change in utility as an additional unit is
consumed. Utility is an economic term used to
represent satisfaction or happiness. Marginal
utility is the incremental increase in utility that
results from consumption of one additional unit.
Understanding the Law
Marginal utility may decrease into negative
utility, as it may become entirely unfavorable to
consume another unit of any product. Therefore,
the first unit of consumption for any product is
typically highest, with every unit of consumption
to follow holding less and less utility. Consumers
handle the law of diminishing marginal utility by
consuming numerous quantities of numerous
goods.
Diminishing Prices
• The Law of Diminishing Marginal Utility
directly relates to the concept of diminishing
prices. As the utility of a product decreases
as its consumption increases, consumers
are willing to pay smaller amounts for more
of the product.
• The law of diminishing marginal utility
directly impacts a company’s pricing
because the price charged for an item must
correspond to the consumer’s marginal utility
and willingness to consume or utilize the Determinants of Demand
good.

1. Changes in the average income

Law of Demand
• the quantity of any good which buyers are
ready to purchase varies inversely with the
price.
• the law indicates that people will buy more of
the product or service if the price decreases.
• slope of demand curve - is downward
movement, which indicates that as the price
of a commodity decreases, the demand for it
increases and vice versa.
2. Changes in price of related goods
- substitute goods - goods that compete
- complementary products - which have no
utility on their own but are combined with
another product
3. Changes in tastes and preferences
4. Changes in consumer's speculation
5. Changes in the size of population

Law of Supply
• the quantity of a good offered for sale at a
given market at a particular time varies
directly with the price.
• supply - refers to the quantity of a good that
will be offered for sale by the seller at a given
price.
• slope of supply curve - moves in upward
direction, as the price of a commodity
increases, quantity supplied also increases.
Determinants of Supply

1. Changes in the cost of production

2. Availability of resources
3. Changes in the number of sellers
4. Changes in technology
5. Weather
6. Changes in government policies

Price Equilibrium
• When the demand and supply are equal, it is
called price equilibrium.
• If the price is below the equilibrium, there is
a shortage; if the price is above the
equilibrium, there is a surplus.
• When there is more demand than the
supply, there will be shortage of goods or
services and the tendency is for the price to
increase. If there is more supply of goods
than the quantity demanded, there is a
surplus of goods/services and the tendency
is for the price to decrease.