Understanding Utility Theory and Market Structures

Utility Theory Concepts

Total Utility (TU): The aggregate satisfaction gained from consuming successive quantities of a good or service.

Marginal Utility (MU): The change in total utility resulting from the consumption of one extra unit of a given commodity.

Law of Diminishing Marginal Utility: As more of a good or service is consumed, the total utility will increase at a decreasing rate (i.e., marginal utility will decrease).

Optimum Purchase Rule: A consumer desiring to maximize total utility should purchase more goods and services until price equals marginal utility (P = MU).

Why Does MU Lead to a Downward Sloping Demand Curve?

• As consumption increases, MU decreases.
• A consumer attempting to maximize their satisfaction will be prepared to purchase to where P = MU.
• Consumers will only purchase additional units at a lower price (relationship between price and marginal utility).
• So, the demand curve must slope downwards to the right with lower prices derived from the MU curve.

Equi-Marginal Rule

Consumer equilibrium is reached when the marginal utility of the last dollar spent on each commodity is equal.

Types of Market Structure

Perfect Competition vs. Monopolistic Competition

• Perfect Competition:
  • Number of Sellers: Many
  • Barriers to Entry: None
  • Product: Homogeneous
  • Demand Curve: Horizontal
  • Short Run Profits: Super/Subnormal
  • Long Run Profits: Normal
  • Control of Price: None
• Monopolistic Competition:
  • Number of Sellers: Many
  • Barriers to Entry: Weak
  • Product: Differentiated
  • Demand Curve: Downward
  • Short Run Profits: Supernormal
  • Long Run Profits: Supernormal
  • Control of Price: Weak

Oligopoly and Duopoly