Unit 1: The Behaviour of Consumers and Businesses
Core concepts to master
Unit 1 builds two microeconomic models. For consumers, know the law of diminishing marginal utility, the assumption of rational self-interest, opportunity cost, and the difference between a movement along a demand curve (caused by price) and a shift (caused by income, tastes, prices of substitutes/complements, expectations, population). For businesses, know explicit vs implicit costs, fixed vs variable costs, the law of diminishing returns, and how marginal cost shapes the supply curve. Also understand market structures (perfect competition, monopoly, monopolistic competition, oligopoly), price elasticity of demand, market failure (externalities, public goods, common resources, asymmetric information), and government intervention (taxes, subsidies, price floors and ceilings, regulation).
Traps examiners set
- Confusing a shift with a movement. A price change never shifts a demand or supply curve; it moves you along it.
- Treating elasticity as slope. A steep curve is not automatically inelastic - elasticity is a ratio of percentage changes.
- Ignoring opportunity cost. It includes the value of the next-best alternative, not just money spent.
- Mixing up diminishing marginal utility with diminishing returns. One concerns consumption satisfaction; the other concerns output from adding variable inputs.
- Forgetting who bears a tax. Incidence depends on relative elasticities: the more inelastic side bears more of the burden.
Worked rule of thumb
For elasticity, use the total revenue test: if price rises and total revenue rises, demand is inelastic; if revenue falls, demand is elastic. Example: a cinema raises tickets from $10 to $12 and attendance falls from 1,000 to 800. Revenue falls from $10,000 to $9,600, so demand is elastic over this range - the price rise reduced revenue.
Always state assumptions and use economic terminology precisely.