Individual economic decision making
Consumer behaviour
Utility theory
● Consumers aim to maximise their utility
● Firms aim to maximise profits
Consumer’s utility
● Total satisfaction received from consuming a good or service
Marginal utility
● Extra satisfaction derived from consuming an extra unit of the good
The demand curve is downward sloping because of diminishing marginal utility.
The law of diminishing marginal utility
● Consumer surplus generally declines with extra units consumed as this
generates less utility than the one already consumed. Therefore,
consumers are willing to pay less for extra units
Utility maximisation
● Maximisation for consumers is when consumers aim to get the most
utility possible from an economic decision. Firms aim maximise profits
+ act in their own interests
● Some firms might have philanthropic owners who seek to maximise
utility of others.
Economic agents respond to incentives, which can allocate scarce
resources to provide the highest utility to each agent.
An entrepreneur’s incentive is profit.
Rewards are positive incentives, whilst penalties make them worse off.
Where incentives are not given properly, resources will be misallocated.
Prices provide signals, which is an incentive to purchase or sell the good.
Firms need an incentive to engage in risk taking, so they innovate. Without
it, production would cost more and there will be a misallocation of
resources.
Intuition uses the feelings or instincts of the consumer - use this when facts
aren’t available or decision are difficult. A rational decision is made using
several steps, and it involves analysis and facts.
, 1) Identify the problem:
E.g. falling profits.
2) Find and identify the decision criteria: The criteria might include how the
decision will affect stakeholders + quality.
3) Weigh the criteria:
Ranked on relative importance.
4) Generate alternatives:
Might consider some alternative options.
5) Evaluate alternative options:
Which alternatives best meet their criteria.
6) Choose the best alternative:
The alternative that meets their criteria.
7) Carry out the decision:
Can see the consequences of decision.
8) Evaluate the decision:
Consider whether this was the best option.
Consumer behaviour
Utility theory
● Consumers aim to maximise their utility
● Firms aim to maximise profits
Consumer’s utility
● Total satisfaction received from consuming a good or service
Marginal utility
● Extra satisfaction derived from consuming an extra unit of the good
The demand curve is downward sloping because of diminishing marginal utility.
The law of diminishing marginal utility
● Consumer surplus generally declines with extra units consumed as this
generates less utility than the one already consumed. Therefore,
consumers are willing to pay less for extra units
Utility maximisation
● Maximisation for consumers is when consumers aim to get the most
utility possible from an economic decision. Firms aim maximise profits
+ act in their own interests
● Some firms might have philanthropic owners who seek to maximise
utility of others.
Economic agents respond to incentives, which can allocate scarce
resources to provide the highest utility to each agent.
An entrepreneur’s incentive is profit.
Rewards are positive incentives, whilst penalties make them worse off.
Where incentives are not given properly, resources will be misallocated.
Prices provide signals, which is an incentive to purchase or sell the good.
Firms need an incentive to engage in risk taking, so they innovate. Without
it, production would cost more and there will be a misallocation of
resources.
Intuition uses the feelings or instincts of the consumer - use this when facts
aren’t available or decision are difficult. A rational decision is made using
several steps, and it involves analysis and facts.
, 1) Identify the problem:
E.g. falling profits.
2) Find and identify the decision criteria: The criteria might include how the
decision will affect stakeholders + quality.
3) Weigh the criteria:
Ranked on relative importance.
4) Generate alternatives:
Might consider some alternative options.
5) Evaluate alternative options:
Which alternatives best meet their criteria.
6) Choose the best alternative:
The alternative that meets their criteria.
7) Carry out the decision:
Can see the consequences of decision.
8) Evaluate the decision:
Consider whether this was the best option.
