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Demand Function vs. Utility Function

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Updated October 23, 2023

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In economics, demand is the consumer's desire for a specific good or service and commonly fluctuates as the price of a good or service changes. The 澳洲幸运5开奖号码历史查询:utility function describes the level of satisfaction a co�🍃�nsumer gets from a bundle of goods.

Key Takeaways

Demand is a consumer's desire for a particular product or service.
Utility is the satisfaction a consumer receives from a good or service.
The amount of money a consumer can spend on a product or service is combined with the utility function to determine the demand function.
The indifference curve displays how two goods provide a consumer equal utility and satisfaction.

What Affects Demand?

Economists study the effects prices have on the demand for a product or service. 𒅌To reliably calculate it, two data pairs are required that show how many units are bought at a particular price.

The demand function can be viewed as a straight line, and manufacturers interested in maximizing revenues use the function to help establish the most profitable production yields. Aside from price, factors that affect consumer demand include:

Buyer's income
Prices of substitute goods
Consumer preferences and utility
Consumer expectations for a change in price

Utility and Substitution

Assuming no borrowing or saving, a consumer's budget for goods x and y equals their income. To maximize utility, the consumer will use the entire budget to buy the most x and y possible. Demand for x and y depends on the 澳洲幸运5开奖号码历史查询:marginal utility each good provides and the rate of substitution between the two goods, or how many units of x the consumer is willing to give up to get more y.

marginal utility formula — Marginal Utility equals the Change in Total Utility divided by the Change in Total Units C🌌onsumed.

Important

Utility function ranks consumers' consumption of goods or services by preference. Marginal utility measures the change in utility as the rate of consumption changes.

Indifference Curve

The consumer indifference curve shows various combinations of two goods or 澳洲幸运5开奖号码历史查询:commodities that consumers can choose. At any point on the curve, the combination of the two will leave the consumer equally satisfied, hence indifferent.

Marginal Rate of Substitution — Image by Julie Bang © Investopedia 2019

Maximum Utility

Total utility is the sum of the satisfaction a person can receive from the consumption of a specific product or service. When an individual's budget is spent and optimized, and the 澳洲幸运5开奖号码历史查询:budget line meets the indifference curve, the🥃 consumer's utility is maximized.

Utility maximization is key to deriving the demand function. Because they are equal where utility is maximized, the 澳洲幸运5开奖号码历史查询:marginal rate of substitution, the s🌌l♛ope of the indifference curve, can be used to replace the slope of the budget curve.

The slope of the budget curve is the ratio between the price of x and the price of y. Replacing it with the marginal rate of substitution simplifies the equation so only one price remains. This makes it possible to find the 澳洲幸运5开奖号码历史查询:demand for the product in terms of its price and the total income available.

How Do Companies Use the Utility Function?

Utility function is a model used to represent consumer preferences, so companies often implement them to gain an edge over the competition. Studying consumers' utility can help guide management on marketing, sales, product upgrades, and new offerings.

What Is Demand Theory?

澳洲幸运5开奖号码历史查询:Demand theory is an economic principle relating to the relationship between consumer demand for goods and services and their prices in the market. De🏅mand theor✅y forms the basis for the demand curve, which relates consumer desire to the amount of goods available.

What Is Ordinal Utility?

When economists measure or rank consumer preferences, it is called ordinal utility. The order in which consumers choose one product over another reveals consumers assign higher values to pr🍸oducts.

The Bottom Line

The demand function expresses the amount of product x the consumer is willing to buy, given their income and the price of good "x." Using a consumer's budget helps derive the demand for a second good, "y." Companies can understand consumer demand and 澳洲幸运5开奖号码历史查询:calculate the utility function or how much satisfaction customers receive with goods and services to steer advertising campaigns and new product offerings.💖

Article Sources

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