Consumer and Producer Behaviour, Utility, Costs, Scale and Market Structures
This section covers consumer and producer behaviour: utility, costs, economies of scale and market structures. The exam tests marginal reasoning and your ability to match cost curves and market models to realistic cases.
Core rules
- Utility is satisfaction. Marginal utility diminishes as consumption rises. A consumer maximises utility when marginal utility per euro is equal across goods: MUx/Px = MUy/Py.
- In the short run, at least one factor is fixed. Total cost = fixed plus variable cost. Marginal cost is the change in total cost from one extra unit. Average cost = total cost divided by output. MC cuts AC at minimum AC.
- Economies of scale lower long-run average cost as output rises: technical, managerial, financial and marketing. Diseconomies arise from coordination and communication problems.
- Perfect competition has many buyers and sellers, homogeneous products and free entry; long-run normal profit. A monopoly has barriers to entry and price-making power. Oligopoly features interdependence and possible collusion. Monopolistic competition features differentiated products.
Worked example
A firm has fixed costs of €100 and variable costs of €10 per unit. At 10 units, TC = €200, AC = €20 and MC = €10. Because MC is below AC, AC is falling. At 20 units, TC = €300, AC = €15; MC remains €10 and still pulls AC down.
Traps
Do not treat fixed costs as zero in the long run. Do not say MC is average cost. Do not confuse economies of scale with diminishing returns, which is a short-run concept. Do not assume perfect competition describes most real markets.