Edexcel AS Economics

Introduction to Markets and Market Failure

1.2 How Markets Work
1.2.1 Rational Decision Making
Syllabus 1.2.1 - Rational Decision Making
The underlying assumptions of rational economic
decision making:
a) consumers aim to maximise utility
b) firms aim to maximise profits (this will be covered later
in the course)
Mick Jagger – Great Economist
https://www.youtube.com/watch?v=nrIPxlFzDi0
Why is Mick Jagger a great economist?
Pizza
This is a model that looks at the amount of satisfaction
(or Utility) we gain from consuming a particular good or
service.
Let us take Pizza as an example.
As you take that first slice of pizza, with melted cheese
dripping off the sides, and eat it, you gain a great deal of
satisfaction (or utility), but with every subsequent piece
of pizza, the amount of satisfaction you gain will fall. This
will occur (in our example) until the 6th piece of pizza
which will make you feel nauseous and will have a minus
utility.
Title – “ Rational Decision Making”
Give a score out of ten for each slice
of pizza as you eat it.
10 = maximum satisfaction gained
Negative numbers = I should have
kept it for breakfast
Pizza slice Satisfaction
1
2
3
4
5
https://www.youtube.com/watch?v=5PVTc4QcuDg
6
Oh dear!!!! What a waste of Pizza!
7
8
Here’s one I did earlier…
Give a score out of ten for each slice
of pizza as you eat it.
10 = maximum satisfaction gained
Negative numbers = I should have
kept it for breakfast
Pizza slice Satisfaction
1 10
2 8
3 6
4 4
5 2
6 0
7 -2
8 -4
Using these figures…
Work out the total satisfaction/ utility earned as you eat each additional slice of
pizza.
Work out the Marginal (extra) Utility, that each extra slice of pizza gives you.
Now plot Total Utility and Marginal Utility on a piece of graph paper. (Utility on Y
axis – up to 30, Quantity of pizza on X axis – up to 8)
Please plot Marginal Utility at midpoints (1.5, 2.5 etc)
Pizza slice Satisfaction/ Total Utility Marginal
Utility Utility
1 10
2 8
3 6
4 4
5 2
6 0
7 -2
8 -4
Using these figures…
Work out the total satisfaction/ utility earned as you eat each additional slice of
pizza.
Work out the Marginal (extra) Utility, that each extra slice of pizza gives you.
Now plot Total Utility and Marginal Utility on a piece of graph paper. (Utility on Y
axis – up to 30, Quantity of pizza on X axis – up to 8)
Please plot Marginal Utility at midpoints (1.5, 2.5 etc)
Pizza slice Satisfaction/ Utility Total Utility Marginal Utility
(mid points)
1 10 10
2 8 18 8
3 6 24 6
4 4 28 4
5 2 30 2
6 0 30 0
7 -2 28 -2
8 -4 24 -4
The Marginal Utility diagram
Point A shows where we
should stop eating pizza
Point B shows us that
where Marginal Utility =
zero, Total utility is at its
maximum
After point B we should
take it home and have
what's left for breakfast!
Extended Questions
1. A Rational person will consume how many slices of pizza?
Why?
2. Where does the Marginal utility curve cut the x axis?
3. How is this related to the total utility? Why?
4. How much pizza will be consumed at a) £8, b) £4 and c) free
Extended Questions
1. A Rational person will consume how many slices of pizza?
Why? 5.5, because any further pizza will reduce his
satisfaction
2. Where does the Marginal utility curve cut the x axis? At the
highest point on the Total utility curve
3. How is this related to the total utility? Why?
4. How much pizza will be consumed at a) £8, (2 slices) b) £4 (4
slices) and c) free (technically until you are full! But we do
not always behave rationally, and carry on eating)
Utility maximisation
1. What is utility maximisation?
2. How can we measure utility?
3. What factors limit our ability to maximise our utility?

https://shop.lego.com/en-GB/Millennium-Falcon-
75192
Utility maximisation
1. What is utility maximisation?
2. How can we measure utility?
3. What factors limit our ability to maximise our utility?
Income levels, can we buy everything that gives us utility
Price levels, if prices change we will not be able to buy
the products, or have to swap from one product to
another
Time restraints – we don’t have the time to work out
which is the product that will maximise our utility.
Conclusions
Once the satisfaction/Utility gained from the last unit is
equal to the price (MU=P) of consuming it, people will
reach satiation point.
Once P>MU, the product will not be consumed
But do we behave rationally?
How many future ideas can we find in this video?
http://www.open.edu/openlearn/society/politics-
policy-people/economics/60-second-adventures-
economics- rational- choice- theory
Rational behaviour - discuss
Additional Ideas
Unit 1.2.10 covers a few more ideas related to these
topics.
Syllabus 1.2.1 - Rational Decision Making
The underlying assumptions of rational economic
decision making:
a) consumers aim to maximise utility
b) firms aim to maximise profits (this will be covered later
in the course)