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1. (i) Explain the Equi-Marginal Principle of consumer behaviour - Leaving Cert Economics - Question 1 - 2012
Question 1
1. (i) Explain the Equi-Marginal Principle of consumer behaviour. (ii) State and explain three other economic assumptions used to analyse consumer behaviour. (b) A... show full transcript
Worked Solution & Example Answer:1. (i) Explain the Equi-Marginal Principle of consumer behaviour - Leaving Cert Economics - Question 1 - 2012
Step 1
Explain the Equi-Marginal Principle of consumer behaviour.
Answer
The Equi-Marginal Principle states that consumers will allocate their income among different goods in such a way that the ratio of marginal utility to price is equal for all goods consumed. This means that consumers maximize their overall satisfaction (utility) by equalizing the marginal utility per unit of currency spent across their consumption choices. Essentially, to achieve maximal utility, a consumer should spend their money so that each last dollar spent on one good yields the same additional satisfaction as that spent on any other good.
Step 2
State and explain another economic assumption used to analyse consumer behaviour.
Answer
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The consumer has a limited income. This assumption posits that the income of the consumer is finite, meaning they cannot satisfy all their wants due to budget constraints. Consequently, they must make choices about what to purchase.
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The consumer acts rationally. This indicates that consumers make decisions that maximize their utility, ensuring their choices are consistent with their preferences. For instance, if two similar products yield different satisfaction levels, a rational consumer would choose the one providing higher satisfaction.
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The consumer is subject to the law of diminishing marginal utility. As consumers increase their consumption of a good, the additional satisfaction gained from consuming each extra unit tends to decrease. Thus, they will consume goods up to the point where the marginal utility equals the price.
Step 3
Explain in respect of Product A: -2.8, what change, if any, the manufacturer should make.
Answer
Since Product A has an elastic PED of -2.8, a decrease in price will lead to a more than proportional increase in quantity demanded. Therefore, the manufacturer should lower the price of Product A to maximize revenue. This increase in demand will offset the loss per unit due to the lowered price.
Step 4
Explain in respect of Product B: -1.0, what change, if any, the manufacturer should make.
Answer
Product B has a unit elastic PED of -1.0. This indicates that a change in price will not affect total revenue, as the percentage change in demand will equal the percentage change in price. Therefore, the manufacturer should leave the price of Product B unchanged to maintain its revenue.
Step 5
Explain in respect of Product C: -0.5, what change, if any, the manufacturer should make.
Answer
Product C, with an inelastic PED of -0.5, suggests that demand is relatively unresponsive to price changes. In this case, the manufacturer should increase the price of Product C, as the decrease in quantity demanded will be less than the percentage increase in price, thereby increasing total revenue.