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SS2: ECONOMICS - 2ND TERM

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Marginal utility theory can be used to derive the demand curve of a household. The normal demand curve slopes downward from left to right showing that consumers are prepared to buy more at a lower price than a higher price. The explanation to this can be found in the law of diminishing marginal utility. The law shows that as additional units of a product are consumed; additional satisfaction (marginal utility) tends to fall.

When a consumer does not have a commodity or has very little of it, marginal utility is usually high and the consumer is prepared to pay high price to obtain it. As he consumes more of it, the marginal utility falls and he is not prepared to pay as much as the earlier units for the consumer to have more of the commodity whose marginal utility has fallen, the price must be reduced. Thus when the prices are high, lower quantities will be purchased and vice versa. This is shown in the table below.

Unit of commodityMarginalPrice (N)
1620
2518
3415
4313
5212
6110
705

The above figure can be used to plot the demand curve.

Evaluation Questions

I. State the law of diminishing marginal utility

2. State the utility maximization 

3. Differentiate between marginal cost and marginal utility.

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Evaluation questions

1. State the law of diminishing marginal utility

2. State the utility maximization 

3. Differentiate between marginal cost and marginal utility.

 

Solution

1. State the law of diminishing marginal utility

The law states that for any household the utility derived from the successive units of a given commodity consumed lead to diminishing or decreasing satisfaction, the consumption of all other commodities being held constant

2. State the utility maximization

Utility maximization states that a household is at equilibrium when the marginal utility of a commodity consumed equals its market prices

MU = P

∴ \( \frac {MU_x}{P_x} = \frac {MU_y}{P_y} \) → For two goods

\( \frac {MU_x}{P_x} = \frac {MU_y}{P_y} = \frac {MU_z}{P_z} \) → For three goods

3. Differentiate between marginal cost and marginal utility

Marginal cost refers to the change in total cost resulting from one unit change in output i.e.

:- \( \scriptsize  MC = \normalsize \frac {\Delta TC}{\Delta Q} \\ \scriptsize \; or \;  MC = \normalsize \frac {TC_2 \; – \;  TC_1}{Q_2 \; – \; Q_1}  \)

Marginal utility refers to increase in total satisfaction derived as a result of consuming an additional unit of a commodity

MU = \( \frac {\Delta TU}{\Delta Q} \)

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