CDS Economics · Microeconomics — Demand, Supply and Market Structure
Choice, Utility and Demand
Opportunity cost and why people trade, how total and marginal utility move together, and what makes a buyer move along a demand curve or shift the whole curve.
Why this matters
Thirteen CDS questions, five of them from the two 2019 papers. Movement along the curve against a shift of the curve was asked in 2020 (II) and again in 2021 (II), and opportunity cost in 2020 (I) and 2021 (II), so these two ideas pay off first.
Concept 1 of 3: Scarcity, opportunity cost and exchange
Time and money are limited, so choosing one thing means giving up another. Economists measure the cost of a choice by the best thing you gave up, not by every thing you could have done. The same idea explains trade: two people swap only when each gets something worth more to them than what they hand over.
Definition
The basic ideas:
- Scarcity: wants are unlimited, resources are limited, so every society must choose.
- Opportunity cost of a choice = the value of the next best alternative given up. Not the sum of all alternatives, and not just the money paid out.
- Voluntary exchange: both sides trade only if each expects to gain, so it is a win-win, not a zero-sum game.
- An economic model simplifies reality to show cause and effect. It can be written in words, diagrams, tables or equations: equations are only one form.
| Idea | What it means |
|---|---|
| Opportunity cost | The value of the next best alternative given upQ Asked twice: CDS 2020 (I) as a sum with daily wages, and CDS 2021 (II) as a definition. |
| Voluntary exchange | Both parties gain, or they would not tradeQ CDS 2021 (II): a pure voluntary exchange is a win-win situation. |
| Economic model | A simplified picture of a theory, in words, diagrams or equationsQ CDS 2019 (II): the statement that is NOT correct is that models can be expressed only through equations. |
| Scarcity | Limited resources against unlimited wants, which forces choice |
Practice this conceptself-check · 4 quick reps
The same idea in a real exam question:
CDS · 2020 · CDS (I) 2020 — General Knowledge · Q116Moderate
Example 1 · Microeconomics — Demand, Supply and Market Structure · Choice, Utility and Demand
Suppose an agricultural labourer earns ₹ 400 per day in her village. She gets a job to work as babysitter in a nearby town @ ₹ 700 per day. She chose to work as agricultural labourer. Which one of the following is the opportunity cost of the agricultural labourer?
Opportunity cost is what you give up, not what you take
If a worker keeps a job paying ₹500 and turns down one paying ₹800, the opportunity cost is ₹800, the wage given up. Adding the two (₹1,300) or taking the difference (₹300) are the usual distractors.
Trade is not a zero-sum game
An option saying one party's profit must be the other's loss is wrong for a voluntary exchange. Both sides gain, or the trade would not happen.
Concept 2 of 3: Total utility, marginal utility and indifference curves
Utility is the satisfaction a good gives. The first glass of water on a hot day gives a lot, the fifth much less. So each extra unit adds less than the one before (falling marginal utility), and total utility keeps rising more and more slowly until it stops rising at all.
Definition
The rules:
- Total utility (TU): satisfaction from all the units consumed.
- Marginal utility (MU): the extra satisfaction from one more unit.
- Law of diminishing marginal utility: as more of a good is consumed, MU falls.
- While MU is positive, TU rises. When MU is zero, TU is at its maximum. When MU is negative, TU falls.
- At maximum TU, average utility (TU divided by units) is still positive, so it is not equal to MU there.
- Indifference curve: combinations of two goods giving the same satisfaction. Indifference curves are convex to the origin, a higher curve means more satisfaction, and two curves never cut each other.
Marginal utility
- total utility from n units
- extra utility from the nth unit
Worked example
Total utility from 1, 2, 3 and 4 mangoes is 10, 18, 22 and 22 units. Find the marginal utility of each mango and say where total utility is at its maximum.
Practice this conceptself-check · 4 quick reps
The same idea in a real exam question:
CDS · 2019 · CDS (I) 2019 — General Knowledge · Q22Moderate
Example 2 · Microeconomics — Demand, Supply and Market Structure · Choice, Utility and Demand
Which one of the following statements is not correct?
At maximum total utility, only marginal utility is zero
When TU peaks, MU = 0 but average utility is still positive (a positive total divided by a positive number of units). A statement that MU and average utility are equal there is wrong.
Indifference curves never intersect
If two curves crossed, the crossing point would give two different levels of satisfaction at once. So a statement that two indifference curves cut each other is always false.
Concept 3 of 3: The law of demand: movement and shift
A demand curve answers one question: how much of this good will people buy at each of its prices, with everything else held fixed. So a change in the good's own price slides the buyer along the curve. A change in anything else (income, tastes, the price of another good, the number of buyers) moves the whole curve.
Definition
The law and its conditions:
- Law of demand: other things constant, a rise in price lowers quantity demanded. The demand curve slopes downward, so its slope is negative.
- Assumptions held constant: consumers' income, tastes and preferences, and prices of related goods (substitutes and complements). A demonstration effect (buying to copy others) is not one of them.
- Movement along the curve: caused only by a change in the good's own price.
- Shift of the curve: caused by a change in income, tastes, population, or prices of substitutes and complements.
- Prices of inputs affect the seller's cost, so they change supply, not demand.
- If the price of one good X rises: demand for X falls, but for another good Y the effect can go either way. Y becomes cheaper compared with X (buyers switch to it), yet buyers are poorer in real terms (they buy less of a normal good).
| Change | Effect on the demand curve for the good |
|---|---|
| The good's own price falls | Movement along the curve (more is bought)Q Asked twice: CDS 2020 (II) asked what does NOT shift the curve, CDS 2021 (II) what moves along it. Both answers are the good's own price. |
| Consumers' income rises | The curve shifts (right for a normal good) |
| Population grows | The curve shifts right |
| Price of a substitute or complement changes | The curve shifts |
| Prices of inputs used to make the good change | No effect on demand; supply changes insteadQ CDS 2022 (I): input prices are the one factor that does not influence quantity demanded. |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2020 · CDS (II) 2020 — General Knowledge · Q34Moderate
Example 3 · Microeconomics — Demand, Supply and Market Structure · Choice, Utility and Demand
Normally, there will not be a shift in the demand curve when
Own price moves along, everything else shifts
Only a change in the good's own price gives a movement along its demand curve. Income, tastes, population and the prices of other goods all shift the curve.
Input prices belong to supply
The cost of raw materials or labour changes how much sellers offer, so it acts on supply. It is the odd one out in a list of things that influence demand.
The effect on the other good is often indeterminate
When good X becomes dearer, demand for X falls. For a second normal good Y, switching from X pushes demand up while the loss of real income pulls it down, so the net effect on Y cannot be told without more information.
Summary — formulas & gotchas at a glance
A revision cheat-sheet for the formulas and gotchas above. Click any concept name to jump back to its full explanation.
Formulas (1)
- Total utility, marginal utility and indifference curves
Marginal utility
Reference tables (2)
Scarcity, opportunity cost and exchange4 rows
| Idea | What it means |
|---|---|
| Opportunity cost | The value of the next best alternative given upQ Asked twice: CDS 2020 (I) as a sum with daily wages, and CDS 2021 (II) as a definition. |
| Voluntary exchange | Both parties gain, or they would not tradeQ CDS 2021 (II): a pure voluntary exchange is a win-win situation. |
| Economic model | A simplified picture of a theory, in words, diagrams or equationsQ CDS 2019 (II): the statement that is NOT correct is that models can be expressed only through equations. |
| Scarcity | Limited resources against unlimited wants, which forces choice |
The law of demand: movement and shift5 rows
| Change | Effect on the demand curve for the good |
|---|---|
| The good's own price falls | Movement along the curve (more is bought)Q Asked twice: CDS 2020 (II) asked what does NOT shift the curve, CDS 2021 (II) what moves along it. Both answers are the good's own price. |
| Consumers' income rises | The curve shifts (right for a normal good) |
| Population grows | The curve shifts right |
| Price of a substitute or complement changes | The curve shifts |
| Prices of inputs used to make the good change | No effect on demand; supply changes insteadQ CDS 2022 (I): input prices are the one factor that does not influence quantity demanded. |
Watch out for (7)
- Opportunity cost is what you give up, not what you take→ Scarcity, opportunity cost and exchange
- Trade is not a zero-sum game→ Scarcity, opportunity cost and exchange
- At maximum total utility, only marginal utility is zero→ Total utility, marginal utility and indifference curves
- Indifference curves never intersect→ Total utility, marginal utility and indifference curves
- Own price moves along, everything else shifts→ The law of demand: movement and shift
- Input prices belong to supply→ The law of demand: movement and shift
- The effect on the other good is often indeterminate→ The law of demand: movement and shift
Test yourself on Microeconomics — Demand, Supply and Market Structure
15 past CDS questions from this chapter, timed at 15 minutes and marked the way the exam marks it. You see your score and every answer the moment you finish. Free to start.