Consumer

Behavior and
Utility
Maximization
Ayesha Afzal
Assistant Professor
Lahore School of Economics

Law of Diminishing Marginal

Utility

Terminology
Utility
Total Utility
Marginal Utility

Marginal Utility and

Demand
Graphically

Law of Diminishing Marginal

Utility
(1)
(2)
(3)
Tacos
Total Marginal
Consumed Utility, Utility,
Per Meal Utils
Utils

2
3
4
5
6
7

0
10
18

]
]
]
24
]
28
]
30
]
30
]
28

10
8
4
2
0
-2

30
TR
20
10
0

6
Marginal Utility (Utils)

0
1

Total Utility (Utils)

Total Utility

Units Consumed Per Meal

Marginal Utility
10
8
6
4
2
0
-2

MU
1

Units Consumed Per Meal

Theory of Consumer Behavior

Consumer Choice and

Budget Constraint
Rational Behavior
Preferences
Budget Constraint
Prices

Utility Maximizing Rule

Allocate Money Income so
that Last Dollar Spent on
Each Product Yields the
Same Marginal Utility

Theory of Consumer Behavior

Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10

(1)
Unit of
Product

(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

(3)
Product B:
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Compare
Marginal
Utilities
Fourth
6
6
16
8
Then
Compare
Per 5Dollar - MU/Price
Fifth
5
12
6
Choose
the4Highest4
Sixth
6
3
Check
- Proceed
to Next
Item2
Seventh Budget
3
3
4

Theory of Consumer Behavior

Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10

(1)
Unit of
Product

(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

(3)
Product B:
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Again,
Compare
Per6 Dollar -16
MU/Price8
Fourth
6
Choose
the5Highest5
Fifth
12
6
Buy
Has
Sixth One of 4Each Budget
4
6 $5 Left
3
Proceed
to 3Next Item
Seventh
3
4
2

Theory of Consumer Behavior

Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10

(1)
Unit of
Product

(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

(3)
Product B:
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

First
10
10
Second
8
8
Third
7
7
Fourth
6
6
Again,
Compare
Per5 Dollar
Fifth
5
Buy
B 4Budget
Sixth One More
4
Proceed
to 3Next Item
Seventh
3

24
12
20
10
18
9
16
8
-12
MU/Price6
Has
6 $3 Left
3
4
2

Theory of Consumer Behavior

Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10

(1)
Unit of
Product

(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

(3)
Product B:
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Fourth
6
6
16
8
Fifth
5
5
12
6
Again,
Compare
Per4 Dollar - MU/Price
Sixth
4
6
3
Buy
One of 3Each 3Budget Exhausted
Seventh
4
2

Theory of Consumer Behavior

Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10

(1)
Unit of
Product

(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

(3)
Product B:
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
(MU/Price)
Utils

First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Fourth
6
6
16
8
Fifth
5
12
6
Final
Result
At 5These Prices,
Sixth
4
4
6
3
Purchase
2 of Item
Seventh
3
3 A and 44 of B 2

Theory of Consumer Behavior

Algebraic Restatement:
MU of Product A
Price of A
8 Utils
$1

=
=

MU of Product B
Price of B
16 Utils
$2

Optimum Achieved - Money Income

is Allocated so that the Last Dollar
Spent on Each Product Yields the
Same Extra or Marginal Utility

Deriving the Demand Curve

Same Numeric Example:

Price Per Quantity

Unit of B Demanded

$2

Price of Product B

Income Effects

DB
0

Substitution Effects

Quantity Demanded of B

Indifference Curve Analysis

Appendix

Budget Line (Constraint)

Income Changes
Price Changes
12

Indifference
Curve Analysis
Demand Curve
Appendix Terms

Total

(Price = $1.50)

(Price = $1)

Expenditure

8
6
4
2
0

0
3
6
9
12

$12
12
12
12
12

10
Quantity of A

Units of A Units of B

Income = $12
PA = $1.50

(Unattainable)

6
Income = $12
PB = $1

4
2
0

(Attainable)
2

Quantity of B

10

12

Indifference Curve Analysis

What is Preferred
Appendix

Downsloping
Convex to Origin
Marginal Rate of Substitution
(MRS)
12
j

Indifference
Curve Analysis
Demand Curve
Appendix Terms

12

10
Quantity of A

Combination Units of A Units of B

2
0

I
2

Quantity of B

10

12

Indifference Curve Analysis

Appendix

The Indifference Map

Equilibrium Position at Tangency
12
10

Quantity of A

MRS =

Indifference
Curve Analysis
Demand Curve
Appendix Terms

8
6

W
X

PB
PA
Preferred
But Requires
More Income
I4

2
0

I3
I1
2

6
8
Quantity of B

10

I2
12

Derivation of the Demand Curve

12

Quantity of A

Appendix

Measurement of Utility
10

Marginal Utility
of A

Price of A

6
X

4
2

I2

Indifference
Curve Analysis
Demand Curve
Appendix Terms

Price of B

10

Quantity of B

12

$1.50
1.00
.50

DB
1 2 3 4 5 6 7 8 9 10 11 12

Quantity of B

I3

Marginal Utility
of B
Price of B

At $1 Price for B,
6 Units are Purchased
Record the Results
As Price of B Increases
to $1.50,
Only 3 Units of B are
Bought
Record the Results
Connect the Points to
Create the Demand
Curve