Theory of Marginal Utility!

One of the very first chapters which caught my attention when I was in secondary 4 is this chapter, marginal utility theory. In economics, utility simply means satisfaction. Higher utility means higher satisfaction and vice versa. Then the term marginal utility refers to the additional satisfaction gained when a product or service is consumed / used / bought.

Theory of Diminishing Marginal Utility

Yes, study of economics deals with a lot of statistics. So we will be seeing plenty of tables, charts, and graphs. As you can examine from the table, the satisfaction gained from eating an additional burger
[ *YumYum*LovesBurgers* ] will result in a lower satisfaction compared to the burger previously. The theory ( and common sense ) suggests that the more you eat, the less satisfaction you will gain at a margin until there is a point where it becomes negative satisfaction ( eating more will make you uncomfortable etc. ). So if we draw a graph on this table, we will see something like this :

As you can see the downward sloping curve of marginal utility, economist then modelled the demand curve based on marginal utility curve. Thus the marginal utility curve is actually also the demand curve! This too explains why as price increases, quantity demanded of an item decreases. If consumers believe that the additional price they are paying is not equal to the additional satisfaction that they will receive, then they will obviously not pay for an extra of it!

The Paradox of Value
- Diamonds vs Water
Ever wondered why water, despite its necessity, is not seen as a precious thing? Diamonds, on the other hand, are highly priced even when it has very little in terms of use. The concept of marginal utility helps to explain this. Water is abundant, while diamonds are relatively scarce. Hence owning an extra diamond will give you higher satisfaction than getting an extra cup of water ( provided you are not in a dessert of course ) because one diamond is extremely valuable no matter how many you have while water becomes less valuable as quantity increases. This shows that marginal utility is the key factor to an item's price rather than its value in use.

Soda vs Newspapers Vending Machines
In western countries ( sadly not in Malaysia yet ), newspapers are sold in vending machines. When the consumers pay for the price of one newspaper, the lid opens up for them to take their morning paper. Unlike the soda machines which only dispense one-for-one, consumers can take as many newspapers as they want from the paper machine. Why wouldn't the newspaper companies worried about that? The concept of marginal utility can be used in this case. Newspaper unlike sodas, has very short shelf life. It just becomes useless overnight but sodas can be kept for years! Therefore, sodas have high marginal utility since you can drink it whenever it will yield the highest satisfaction. Newspapers have low marginal utility as it cannot be kept and reselling it is just not worth the time as there is abundant of supply if everyone does so. Newspaper companies therefore rely on the trust that consumers will only take as much as they need.

Introduction to Supply

In theory, supply refers to the quantity of goods that producers are willing and able to supply at various prices over a given time period. Unlike a demand curve which is downward sloping, supply curve would be the total opposite. A common supply curve would be as follows ; 

Price-Supply relationship

Why upward sloping?

Imagine if under a contract, you were given a piece of land. You must produce a combination of potatoes and carrot and maximize your profits. Let say that both of them are priced the same and uses the exact same amount of land per acre to produce a kilo of produce, thus you would be utilizing the land to produce both equal in quantity ( assumes that there is no extra cost involved for both the products ). If the price of carrots were to increase, it would make sense for the producer to shift most of his land to plant carrots hence selling more carrots. Therefore the quantity supply in the market would increase as the price of a product goes up because it is more profitable now than before to produce that product, all others being equal.

In this globalized economy, where there's consumer demand there will be a supply ( of course, the demand must be logical and attainable at the same time ). To which comes first is still debatable. According to Say's Law ( Named after Jean-Baptiste Say ) , supply creates its own demand. The idea is that when people produce any commodities (supply) and earn money from it, the money is useless if it is not used. Therefore money gained from selling a product is used to buy another product which they want (demand). Though this law became a conflict for the two main schools of economics, the classical and Keynesian as the former believes that production will lead to a growing economy while the Keynesian argues that growth comes only from increased demand.

Introduction To Demand

I'm pretty sure that most of us knows what 'demand' is, therefore I will not go much into details of the long and tiring explanations given by textbooks. So everyone has our own needs and wishes to afford something. Etc. food, clothing, home. Basically in economics, demand means the quantity of an item which is desired by a person while quantity demanded is the amount which the person is willing, and at the same instance, afford to buy it in a given time period. The table below shows the common relationship between the price of a good and the quantity demanded by consumers ( in a free market ).

The price-demand relationship

As shown in the diagram, the common demand curve shows an inverse relationship between price and its quantity demanded. This is true according to the Law of Demand ( states that the quantity demanded lowers as price increases, all others being equal ). Mainly because of  2 reasons ; the substitution effect and the income effect.

Substitution effect :

 In classical economics, we commonly assume that all humans are rational and will try to maximize our satisfaction* [utility]. To illustrate this, let's say you are given choices between two vegetables, the carrot and the cabbage, and say that both of them will give you the same amount of satisfaction (per kilo). 

If the carrot is originally priced at $1 but later on increased to $1.50, which product will a rational man buy? If that man had been buying carrot all along, then now he would substitute carrot with cabbage because it is more worthy to do so at a given fixed income. Therefore, as the price of a product is increased, people will demand less of a product, substituted by another product. This is given that that particular product has fair / close substitute. The recent rise in the price of sugar ( up roughly 30cent ) due to subsidy rationalization in Malaysia did less to reduce its demand as sugar unlike most commodities has very less substitutes ( expensive artificial sugar eg. aspartame ) We will discuss the responsiveness [elasticity] of consumers to the price in the coming posts.

Income effect :

According to 2012 labour force survey of Malaysia, there is a roughly a total of 20mil working labour. Of these working labours, mainly are employed at a fixed rate of wage thus most of us have a limited disposable income to spend on goods and services per month. Therefore, we make choices everyday to fully make use of our hard earned money. As a product got more expensive than before, consumers will cut back on its consumption because they cannot afford to buy the same amount since there is no increase in wages. With only $10 to spend  on vegetables, will you be able to buy 10 carrots as you did before the price hike?

Both of these effects cause the quantity demanded by consumers to fall as price increases. But there are circumstances which the demand curve shows a positive relation between price and quantity demanded which violates the Law of Demand.

Such goods, which are rather rare, are called Veblen goods ( Named after US economist Thorstein Veblen ). These goods are mainly driven by psychological factors such as fear and status-seeking. Another example of goods which follow such demand curve would be Giffen goods ( Named  after Scottish economist Sir Robert Giffen ). However there are considerable debates on its existence. I too shall cover these topics in coming posts.

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The topic 'Demand' is a very large chapter , and it will be a few posts before I can cover most of it. Do subscribe and  look forward to future posts. To be honest, microeconomics is not my strong point but it is very interesting. Anyway, thanks for reading and again feel free to to comment to add or to point out any mistakes. 

Updated :

Today , I went to an incredibly big book sale called 'The Big Bad Wolf' , in Mines Convention Centre.

As you can see the numbers of people there, sales are great! The main reason why is there such huge crowd is that all books were priced at 75-90% discount ( very worthy indeed even though they are not newly published, I bought only 4 books ). Explained earlier, a very low price ( relatively ) will indeed attract huge demand for it.

=Me=101=

''It always seems impossible until it's done."

-Nelson Mandela-

Passed away peacefully on 5th December 2013, Nelson Mandela is one of my favorite role models in life. His legacy of fighting oppression and gaining an equal ground for all inspired me. To begin with, this blog was created as a holiday project of mine to summarize and go in depth into the many topics of conventional economics in layman terms. The reason I touched on Mandela is because I too adore the concept of an egalitarian society. Economics, on the other hand have been a great passion since I'm 16. Thus, in the future I wish to pursue a degree in economics as a stepping stone, somewhat hoping to make a difference in this highly capitalist society. I have recently completed my A-level studies and decided that by making this blog I will be able to enhance my knowledge on economics as well as a great way to pass my 10-months' holiday till the next university intake in Sept 2014. Do take note that I am not the best writer and neither do I have a great proficiency in English. I have yet to step foot into any university but I will try my best to give the best of information I could as I am sure there are a lot more for me to learn. If there's any mistakes, errors, additional info etc. , feel free to comment. The posts will be mainly a summary of economic terms, ideas and occasionally some examples from Malaysian economy.