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A* Microeconomics Notes
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Individual Economic Decision Making2.1 Consumer Behaviour
Utility Theory: total and marginal utility, diminishing marginal utility
● When making economic decisions, consumers aim to maximise their utility and firms
aim to maximise profits
● A consumer's utility is the total satisfaction received from consuming a good or
service
● Marginal utility is the extra satisfaction derived from consuming one extra unit of the
good
● The demand curve is downward sloping because of diminishing marginal utility. The
law of diminishing marginal utility suggests that consumer surplus generally declines
with extra units consumed. This is because the extra unit 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 generate the greatest utility
possible from an economic decision. Firms aim to generate the highest profit
possible.
● It is assumed that economic agents only act in their own interests.
● Some firms might have philanthropic owners who seek to maximise the utility of
others.
Rational Economic Decision Making and Economic Incentives
● Economic agents respond to incentives which can allocate scarce resources to
provide the highest utility to each agent.
● For the entrepreneur in the firm, the incentive for taking risks is profit
● Rewards are positive incentives which will make consumers better off whilst penalties
make them worse off
● Where incentives are not given properly resources will be misallocated
● Prices in market economies provide signals to buyers and sellers which is an
incentive to purchase or sell the goods. This changes their behaviour.
● For example, a high demand and high price for a good will give an incentive to firms
to allocate more resources to producing that good.
● An entrepreneur wants to voice loss and gain profit which makes them want to
innovate so they can reduce their prosecution costs and improve the quality of thor
products
● Firms need an incentive to engage in risk taking so they innovate. Without innovation
production will cost more and there will be a misallocation of resources
● A firm or an individual can make decisions using intuition or rationally. Intuition ises
the feelings or instinct of the consumer and does not use facts. Businesses use this
when they do not have access to facts or when making decisions is difficult. A
rational decision is made using several steps and it involves analysis and facts.
Diagram
, 1. Identify the problem: for a firm this might be falling profits
2. Find and Identify the decision criteria: the firm might have to find information or
criteria that will increase their profits. The firm's criteria might include, for example,
keeping a certain number of employees or not to change the price of their goods. The
criteria might include how the decision will affect stakeholders (the customer and the
staff for instance) and how the quality might be affected
3. Weight the criteria: the firm will have to rank the criteria based on their relative
importance. They might think keeping all of their employees is the most important for
example.
4. Generate alternatives: the firm might consider some alternative options. For instance
they might think that moving their premises somewhere else will reduce costs and
hence increase profits. Perhaps they will consider a loyalty scheme or promotion for
the consumer. Alternatively, they might decide to reduce the size of their workforce.
5. Evaluate Alternative options: the firm might now consider thich of the alternatives
meet their criteria the best and help them increase their profits the most.
6. Choose the best alternative: now the firm will choose the alternative they think meets
their critierai
7. Carry out the decision: the firm can now see what the consequences of the decision
are
8. Evaluate the decision: after seeing what effect the decision has on the firm they can
consider whether this was the best option or not.
Limitations:
● This is not always the best or most realistic way for firms to make decisions. Although
it might be fairer than making an intuitive decision, it takes significantly longer to
decide which is not practical in a firm with strict time constraints.
The importance of the Margin when Making Choices:
● Thinking at the margin means thinking about the effect of an additional action.
● An action would involve a marginal increase in product or marginal cost. For
example working for one extra hour could produce 6 more units of output. However
each extra unit of output costs 10 minutes.
● Thinking at the margin is important because it allows consumers to keep thinking
ahead. It prevents consumers from thinking about things they have already done and
allows them to consider how to maximise their utility now or in the future.
● When making choices, margins can also increase productivity since the most
important tasks which maximize utility the most are the ones which are prioritised.
2.2 Imperfect Information
The importance of information for decision making:
● Symmetric information: this is where consumers and producers have perfect market
information to make their decision. This leads to an efficient allocation of resources.
● There could also be imperfect information. Consumers might pay too much or too
little, and firms might produce the incorrect amount. For example, monopolies might
exploit the consumer by charging them more than they need to.
The Significance of Asymmetric Information
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