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Normal Goods and Consumer's Demand Curve

Explain what is meant by a normal good and comment on the link between total utility, marginal utility and a consumer’s demand curve for that good.

Category:

Consumer Theory and Demand Analysis

[CIE A level November 2019]

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Answer

Diagrams are important here in order to make a clear explanation.


Step ➊ : Define normal goods, total utility and marginal utility in the introduction.


It has been shown that total utility and marginal utility can be used to derive a consumer demand curve for a normal good. A normal good is a good that has a positive relationship between income and demand. This means that following a rise in consumer income, there will be a rise in the demand for normal goods and vice versa. Examples of normal goods include clothing, food or household appliances. Total utility is the overall satisfaction that is derived from the consumption of all units of a good over a given time period. Marginal utility is the benefit gained from consuming one additional unit of a product or service. To demonstrate how marginal utility can be used to derive an individual demand curve for a normal good, it is important to understand the law of diminishing marginal utility and the equi-marginal principle.


Step ➋ : Explain the law of diminishing marginal utility


The law of diminishing marginal utility states that there will be a fall in marginal utility as consumption increases. Let’s take the example of a normal good such as milkshake. If a person buys a milkshake he will get a lot of satisfaction from consuming it, especially in hot weather. However, if he consumes a second one, he will likely to get less satisfaction than from the first milkshake. A third milkshake will yield even less satisfaction. There may be a point where marginal utility is negative as consumption increases. The person may get dissatisfaction from consuming a forth milkshake.


Step ➌ : Explain the equi-marginal principle


The marginal utility analysis can be also used to show how a rational person decides what combination of goods to buy given their limited income. The equi-marginal principle states that a consumer will get the highest utility from a given level of income when the ratio of the marginal utilities is equal to the ratio of the prices.

The formula for the equi-marginal principle is as follows :

MUa/MUb = Pa/Pb

where
MU = marginal utility
P = the price
a and b = different products


Step ➍ : Explain how marginal utility is used to derive an individual demand curve


It is possible to use marginal utility to derive an individual demand curve. The marginal utility approach gives a rationalisation of the demand curve.

Let's take an example. Initially the equilibrium is where MUa/Pa= MUb/Pb. If the price of good A falls relative to good B, the utility from the last pound spent on good A will be greater than the utility from the last pound spent on good B. This can be written as MUa/Pa > MUb/Pb .

The consumer will, therefore, increase total utility by consuming more on good A and less on all other goods. This will have the effect of decreasing the marginal utility of A and the consumer will continue increasing his expenditure on A until the equality is restored (until where MUA/PA= MUB/PB ). Thus, a fall in the price of a good will, ceteris paribus, give rise to an increase in a consumer’s demand for it. The conclusion is that the demand curve for a good is downward sloping.

Figure 1

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In Figure 1 , units of milkshake, are shown along the X-axis and total utility (TU) and MU are measured along the Y-axis. MU is positive and TU is increasing till the 4th milkshake. After consuming the 5th milkshake, MU is zero and TU is maximum.

Figure 2

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In Figure 2 , the marginal utility curve MUx is negatively sloped. It shows that as the consumer acquires larger quantities of good x, its marginal utility diminishes. Consequently at diminishing price, the quantity demanded of the good x increases as is shown in figure 2 b. There is clearly a relationship between the marginal utility curve (Mux) and the consumer demand curve (D)

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♕ Marking scheme
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Definition of a normal good, explanation of total utility and links to total consumption. Derivation of falling marginal utility as consumption increases linked through equi-marginal consumption and price change of a product to the demand curve.

L4 (9–12 marks): For clear explanations of the three terms and reference to the demand for a good. Establishment of the equi-marginal rule MUx/Px = MUy/Py. The effect of a change in the price of a good on the ratio and the need to adjust the quantity demanded and hence MU in order to return to equilibrium must be explicitly stated.

L3 (7–8 marks): For clear explanations of two of the terms and reference to the demand for a good. Establishment of the equi-marginal rule MUx/Px = MUy/Py.

L2 (5–6 marks): For a clear explanation of 2 of the terms and an attempt to link it to the demand curve.

L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial

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