Economic Objectives

What do people want to achieve by being economically active?

 

The first thing we learned studying Economics was that we had scarce resources and unlimited wants. Unlimited wants suggests that if people could have everything, they would. The reason for this is because traditional Economics assumes all people want to maximise their welfare (also known as utility maximisation).

 

However, it's not that simple. As we all know, the way the world works is that everything comes at a cost. "There is no such thing as a free lunch" comes to mind. Let's say we are measuring benefits purely in monetary terms. The benefit to me of eating my lunch now is £5, for example. However, I walk into the shops and I notice all of the lunches available come at a cost of £10 or more. Now what does this mean?

 

Benefit of eating lunch now = £5

Cost of eating lunch now = £10:  therefore,

Net Benefit of eating lunch now = £-5 [£5 - £10]

 

So overall, eating my lunch now comes at an overall cost to me and this would suggest that I don't eat lunch now and I wait till later. Maybe later the benefit of eating will rise (because perhaps I will get more hungry and the benefit of eating will rise) or alternatively maybe I find a different store with a lower lunch cost.

 

Understanding marginal relationships

To understand this in greater detail you need to understand the idea of margin or marginal relationships in Economics. Margin just how much more of something there is from one additional unit.

 

For example:

Marginal Cost asks -> what's the additional cost when one more unit is made?

Marginal Revenue asks -> what's the additional revenue when one more unit is sold?

 

What we were talking about in the above lunch example was utility. What would marginal utility mean then? (Remember, utility/benefit/welfare all basically mean the same thing)

Marginal utility asks -> what's the additional benefit when one more unit is consumed?

 

This is different to Total Utility and you need to understand this. Let's go back to the lunch example and break it down in stages.

1) Right now, I'm feeling hungry and I want some lunch. The benefit of eating lunch for me is feeling full and the pleasure I get from eating my food. Let's assume this to be £5 like before. Thus, this additional meal is bringing me utility of £5.

2) I find some lunch for £5, therefore it makes sense for me to pay this price as this is what I value it at. I sit down and eat my lunch.

3) I've eaten my lunch and I'm still feeling a bit peckish. That sandwich was good; should I have another?  Like I said I'm not really hungry, just a bit peckish. Therefore the benefit of eating something additional will be lower than before. The benefit of eating a second time is £1.50. But, lunch still costs the same (£5). Therefore, I will not buy a second time.  (this is an example of diminishing marginal utility. Consuming more and more lunch will not be enjoyable forever!)

 

So, marginal utility at first was £5 when I was hungry, but consuming an additional unit of lunch brought only a benefit of £1.50.

Therefore:

Marginal Utility (0-1 units of lunch) = £5

Marginal Utility (1-2 units of lunch) = £1.50

Total Utility of consuming both units = £6.50

 

A rational consumer will always try to increase overall benefits to them.

By consuming 1 unit of lunch, the overall benefit is £0, £5 benefit and £5 cost.

By consuming 2 units of lunch, overall benefit is £-3.50, because total benefit is £6.50, but the overall cost paid is £10 (£5 x 2).

Therefore, I will not purchase 2 units of lunch.

 

You need to know that consumers will choose to consume the good up till the point wheremarginal utility = price

If my 2nd unit of lunch was £1.50 or lower in price, then (being rational) I probably would have purchased it!


So all economic agents are assumed to be utility maximisers. What does this mean?

For consumers: they will maximise utility by buying the best products possible at the lowest price possible. If they're workers, we'll assume they want to maximise their income while working as little as possible.

For firms: A firm's profit is the traditionally accepted way of measuring their welfare. Greater profits means greater rewards for the entrepreneur. Therefore, firms want to charge the highest possible price and have the lowest possible cost of production to increase their profits.

You could argue that some firms are not for profit (like charities), but these are exceptions to the rule. (But more money raised for charity will still provide the people inside the business with psychological benefit!)

For governments: A government's job is to balance the resources of a country and do the best job of satisfying needs and wants of its residents. This could be by improving certain aspects of the economy such as GDP growth, unemployment, inflation etc. They work toward keeping the economy stable and keeping people happy. If they do a good job, they should get voted in next time!


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