CHAPTER 4: THE RATONAL

CONSUMER
Nguyen Thi Minh Thu, FIE, FTU 1
 2

THE THEORY OF CONSUMER

BEHAVIOUR
I. CONSUMER SURPLUS
II. CONSUMER CHOICE

Nguyen Thi Minh Thu, FIE, FTU

Consumer surplus
Price

$399 An Potential Willingness

buyers to pay
An $399
349 Bình Binh 349
Chi 300
300 Chi Dương 250
Đạt 100
250 Dương
A consumer’s willingness to
pay for a good is the
100 Đạt
maximum price at which he
or she would buy that good.
D
0 1 2 3 4 5
Quantity
Graphically, the TWTP is the
area below the demand curve.
Price
A’s net gain:
$399 − $270 = $129

$399 A
B’s net gain:
$349 − $270 = $79

349 B
C’s net gain: $300 −
$270 = $30
300 C Those individual net
270 Price = $270 gains are known as
250 D individual consumer
surpluses.
100 Đ

D
0 1 2 3 4 5 Quantity
Consumer Surplus
Individual Consumer surplus is the net gain to a
buyer from the purchase of a good.
It is equal to the difference between the buyer’s
willingness-to-pay and the expense.
Total consumer surplus is the sum of the individual
consumer surpluses of all the buyers of a good.

CS = TWTP - TE
Consumer Surplus

Price of
iPad
The total willingness-to-pay is
equal to the area below the
demand curve.

TWTP

$500

0 1 million
Quantity of iPads
Consumer Surplus

Price of
iPad
The total consumer surplus
generated by purchases of a good
at a given price is equal to the area
below the demand curve but above
Consumer
that price.
surplus

$500 Price = $500

TE D

0 1 million
Quantity of iPads
 CONSUMER SURPLUS 8

 At q0: Willingness-to-
P
pay for this unit is equal
to the price F

CS is the area above the CS

P0 A
price and below the
demand curve
TE
D
 CS0 = S( P0FA)
0 q0 Q

Nguyen Thi Minh Thu, FIE, FTU

 CONSUMER SURPLUS 9

At q1:
CS1 = S( P0FBC) P

F
At q2: B

CS2 = S(P0FA) -S( AHG) A H

P0
C
G

0 q1 q0 q2 Q

Nguyen Thi Minh Thu, FIE, FTU

 10

CONSUMER CHOICE

1. INDIFFERENCE CURVE
2. BUDGET CONSTRAINT
3. OPTIMAL CHOICE
4. INCOME EFFECT AND
SUBSTITUTION EFFECT

Nguyen Thi Minh Thu, FIE, FTU

 11

1. INDIFERENCE CURVE

The utility of a consumer is a measure of the

satisfaction the consumer derives from the
consumption of goods and services
A utility function gives the total utility generated by a
consumption bundle.
The unit of utility is a util.

Nguyen Thi Minh Thu, FIE, FTU

 12

KEY DEFINITIONS

Marginal utility is the change in total utility resulting

from the consumption of an extra unit.

If the total utility function is continuous:

MU = TU’(Q)

Nguyen Thi Minh Thu, FIE, FTU

 13
CALCULATING MARGINAL
UTILITY

Q TU MU

0 0 -

1 10 10

2 18 8

3 24 6

4 28 4

Nguyen Thi Minh Thu, FIE, FTU

 14
CALCULATING MARGINAL
UTILITY
 Eg1: TU = 20Q – Q2
MU = TU’ = 20 – 2Q

 Eg2: TU = XY
MUX = TU’ (X) = Y
MUY = TU’ (Y) = X

Nguyen Thi Minh Thu, FIE, FTU

 15
THE LAW OF DIMINISHING
MARGINAL UTILITY
 A psychological observation
MU
 As a consumer consumes
more and more units of a 10

specific commodity in a 8
6
certain period of time, utility 4
from the successive units MU

goes on diminishing.
0 1 2 3 4 Q

Nguyen Thi Minh Thu, FIE, FTU

 16
BASIC ASSUMPTIONS

1. Complete preferences
2. Transitivity
3. Non-satiation (prefer more to less)

Nguyen Thi Minh Thu, FIE, FTU

 17
INDIFFERENCE CURVE
An Indifference curve captures all
combinations of commodities that yield
the same level of utility.

Suppose that a person consumes two

goods, i.e. X and Y.

Nguyen Thi Minh Thu, FIE, FTU

 18
INDIFFERENCE CURVE
Properties of
Indifference curves Y

The farther from the

origin an IC is, the
higher utility it Y1
displays.
U2
U1

0 X1 X2 X

Nguyen Thi Minh Thu, FIE, FTU

 19

INDIFFERENCE CURVE

ICs never cross each

other Y

A
U1

U2

Nguyen Thi Minh Thu, FIE, FTU 0 X

 20

INDIFFERENCE CURVE

 When an individual consumes more

units of good X, he/she can reduce the
amount of good Y while enjoy the
same level of utility.
 ICs slope downward.

Nguyen Thi Minh Thu, FIE, FTU

 INDIFFERNCE CURVE 21
 Marginal rate of substition of
good X for good Y, denoted as
MRSXY, reflects the amount of Y
good Y the consumer has to give
up to consume an extra unit of
good X holding the same level of
utility.
Y1 A

ΔY
Y2 B
IC
ΔX

0 X1 X2 X

Nguyen Thi Minh Thu, FIE, FTU

 22
INDIFFERENCE CURVE
 Moving from A to B:
Y
Changes in the amounts of X and Y
is ΔX and ΔY
Change in total utility
Y1 A
= Marginal utility × Change in
ΔY
quantity.
Y2 B
IC
ΔX

0 X1 X2 X

Nguyen Thi Minh Thu, FIE, FTU

 23
INDIFFERENCE CURVE
ΔTUX = MUX * ΔX Y

ΔTUY = MUY * ΔY
ΔTU = ΔTUX + ΔTUY = 0
Y1 A
MUX * ΔX+ MUY * ΔY=0(1) ΔY
Y2 B
IC
ΔX

0 X1 X2 X

Nguyen Thi Minh Thu, FIE, FTU

 24

INDIFFERENCE CURVE

From equation (1), we have

IC’s slope =

Nguyen Thi Minh Thu, FIE, FTU

 INDIFFERENCE CURVE 25

 Marginal rate of substitution of good X for good Y

decreases as the consumer consumes more of good X
|ΔY/ΔX| negatively covariates with X
ΔY/ΔX positively covariates with X
 Y’(X) positively covariates with X
 Y’’ >0
ICs bow inward.

Nguyen Thi Minh Thu, FIE, FTU

 26
TWO EXTREME CASES

 PERFECTLY  PERFECTLY
COMPLEMENTS SUBSTITUTES
Y Y

0 X 0 X

Nguyen Thi Minh Thu, FIE, FTU

 27
BUDGET LINE

A budget constraint requires that the

spending of a consumer’s consumption
bundle be no more than the consumer’s
total income.
Suppose we have a consumer with
income I to spend on two commodities X
and Y with price PX, PY correspondingly.

Nguyen Thi Minh Thu, FIE, FTU

 28
BUDGET LINE
Payment for good X is PX * X
Payment for good Y is PY * Y
PX * X + PY * Y = I
Y = - (PX/ PY) * X + I/ PY (2)
Equation (2) is the equation of budget line.
Its slope is - (PX/ PY) BL is negatively
sloped.

Nguyen Thi Minh Thu, FIE, FTU

 BUDGET LINE 29

If income changes while

prices of both goods Y

remain unchanged, I/PY

budget line will shift
parallel.
If price of one good
changes while holding
income and price of the 0 I/PX X
other good, budget line
will pivot.
Nguyen Thi Minh Thu, FIE, FTU
Optimal Consumption Choice
The optimal consumption
bundle is the consumption
bundle that maximizes a
consumer’s total utility given his
or her budget constraint.
 31
OPTIMAL CHOICE
Among the five Y
bundles, the consumer
I/PY
C is possible but A G

inefficient M
U3
A, B, M are both C
possible and efficient, U2
B
of which M brings the U1
BL
highest level of 0 I/PX X
satisfaction. Thus M is
the optimal bundle.
Nguyen Thi Minh Thu, FIE, FTU
 32
OPTIMAL BUNDLE
 At point M Y

IC’s slope= BL’s slope I/PY

A
-MUX/ MUY = - PX/PY
M
MUX/ PX = MUY/PY
U2
The marginal utility of B
BL
a dollar spent on each 0 I/PX X
good is the same.

Nguyen Thi Minh Thu, FIE, FTU

 33

Extreme cases
Y Y

0 X 0 X
 34

PRACTICE
A consumer has an utility function
U = X.Y
Price of good X and Y respectively is
10 and 15 dollars per unit.
His budget for these goods is 600$.
 How many units of good X and Y
the consumer will buy?

Nguyen Thi Minh Thu, FIE, FTU