Mic 5

Microeconomics All Rights Reserved
© Oxford University Press Malaysia, 2008

5– 1
CHAPTER
5 Consumer
Theory
Choice

5– 2
INTRODUCTION
Consumer Choice Theory is important in

economic activities because producers are
always competing with each other to get
consumers to buy their products. Consumer
Choice Theory further explains the existing
behaviour of consumers.

5– 3
THEORY OF UTILITY
Utility means satisfaction gained by the customer
from the consumption of goods and services.
Utility is defined as affordability of the consumer
to consume goods and services that will give
satisfaction to the customer.
Theory of Utility: Satisfaction received by the

consumer or pleasure from consuming a good is
a basis to make a choice of goods and to value
goods. Economists term this satisfaction as utility.

5– 4
TYPES OF UTILITY
There are two approaches of utility, which
are ordinal and cardinal utility.
1) Cardinal Approach
Utility is measured using the unit called “utils”. For
example, drinking one glass of lemonade will give 2 unit
of utils and a cup of coffee will give 1unit of utils.

5– 5
TYPES OF UTILITY (CON’T)
2) Ordinal Approach
Satisfaction cannot be measured. An
ordinal measure means that the exact
number does not matter, but rather the
relationship between those numbers
matter.

5– 6
CARDINAL UTILITY THEORY
Cardinal Utility Theory is an approach that says
that utility can be measured using the unit “utils”.
For example, eating bread gives 8 utils, while
eating biscuit gives 4 utils, which means bread
gives twice as many utils compared to biscuit.
When the level of utility is associated with the
consumers willingness to pay. The higher the
price, the higher the satisfaction will be.

5– 7
TOTAL UTILITY(TU)
Total utility (TU) is the total satisfaction

that a person gains from the consumption
of goods and services.

5– 8
MARGINAL UTILITY (MU)
Marginal utility (MU) is the change in total
utility derived from consuming extra one unit
of the same goods and services. The formula
to calculate the marginal utility as follows:
Change in Total Utility

MU =
Change in Quantity

5– 9
TOTAL UTILITY
AND MARGINAL UTILITY
Based on the table above, MU of the 1st unit is

equal to TU.
When we add up the MU until the
consumption of the 6th unit, we will get 72 utils,
which is equals to the total utility of that unit.
5– 10
LAW OF DIMINISHING
MARGINAL UTILITY
Law of Diminishing Marginal Utility is a
point where marginal utility obtained
by consuming additional units of a
good starts to decline, ceteris paribus.

5– 11
LAW OF DIMINISHING
MARGINAL UTILITY (CON’T)
This law states that the marginal utility

curve is downward sloping and the total
utility curve will become flatter.
The TU curve is equal to the slope of the
MU curve.

5– 12
CONSUMER EQUILIBRIUM
WITH ONE GOOD
One of the way to maximize satisfaction from our limited
income is to measure utils with the value of money. So, the
unit utils become value of consumption.
Marginal utility (MU) becomes the amount of money that a
consumer is willing to pay in order to get an extra unit of good.
If the consumer is willing to pay RM1 for a can of soft drink,
the MU of the can of soft drink will be MU=RM1.
Herewith, when consumption only involves one good, then
consumer will maximize satisfaction when marginal utility of
consumption of that good equal to price.

5– 13
CONSUMER EQUILIBRIUM WITH
TWO GOODS OR MORE
In real life, consumers can choose a variety of
goods and services.
When the consumer needs to divide his income
for two or more goods, equilibrium is obtained
when
MUn MUn = Marginal Utility of goods
Where
Pn P = price of goods
5– 14
ORDINAL UTILITY THEORY
In this approach, the satisfaction received by

the consumer can’t be quantitatively stated.
This approach states that different goods that
are consumed by consumers bring different
levels of satisfaction.

5– 15
PREFERENCES OF A TYPICAL
CONSUMER
FIRST ASSUMPTION
Preferences are complete and can be ranked.
The ranking is done by the consumer in all
market baskets.

5– 16
CONSUMER (CON’T)
SECOND ASSUMPTION
Preferences are transitive
Transitivity means that if a consumer prefers
market basket A to B and B to C, then the
consumer prefers A to C.

5– 17
CONSUMER (CON’T)
THIRD ASSUMPTION
Consumer is presumed to prefer
more of any good to less of any
good.

5– 18
INDIFFERENCE CURVE
ANALYSIS
Consumer’s preferences allow an individual to
choose among different goods and services.
An indifference curve analysis shows the
combination of consumption that makes the
consumer satisfied when he chooses both goods.

5– 19
FOUR PROPERTIES OF
INDIFFERENCE CURVES
1. Higher indifference curves are preferred to
lower ones.
2. Indifference curves are downward sloping.
3. Indifference curves do not cross each other.
4. Indifference curves are bowed inwards.

5– 20
INDIFFERENCE CURVE EXAMPLES
PERFECT SUBSITUTES
Certain goods are perfect subsitutes in

consumption.
For example, you will be willing to trade ten
cents and two five cents because it offers the
same satisfaction.

5– 21
INDIFFERENCE CURVE EXAMPLE
PERFECT SUBSITUTES (CON’T)
These goods need one another before it can
consumed.
To consume a pair of shoes, we need a left
and a right shoe together.
Missing shoes would make the pair
incomplete.
5– 22
THE BUDGET CONSTRAINT
This is a set of basket that a

consumer can purchase with a
limited amount of income.

5– 23
COMBINING THE INDIFFERENCE
CURVE AND THE BUDGET LINE
By combining the indifference curve and

the budget line, we can determine the
market basket that the consumer will
actually choose.

5– 24
CORNER SOLUTION
This is a situation in which a particular good

is not consumed at all by an individual
because the value of the first unit is less than
its cost.

5– 25
CHANGES IN INCOME AND
CONSUMPTION CHOICES
A change in income will affect consumption

choices by changing the set of market
baskets that the consumer can afford.
This results in a shift in the budget line.

5– 26
NORMAL GOODS
These are goods where the consumer

purchases more when income rises.

5– 27
INFERIOR GOODS
These are goods where consumption is

inversely related to income.
This means that as income rises, the
consumption of inferior goods will drop.

5– 28
PRICES CHANGES AND
CONSUMPTION CHOICES
Changes in price would affect the market

basket that the consumer chooses.

5– 29
INCOME EFFECT AND
SUBSTITUTION EFFECT
Income Effect
When the price of a good falls, the consumer’s real
purchasing power would increase.
Substitution Effect
When the price of a good falls, the consumer has an
incentive to increase consumption at the expense of
another more expensive good.

5– 30
CONSUMER SURPLUS
This is the net benefit or gain secured

by an individual from consuming one
basket instead of another.

5– 31
DEMAND CURVE TO MEASURE
CONSUMER SURPLUS

5– 32

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Microeconomics All Rights Reserved

© Oxford University Press Malaysia, 2008

Microeconomics All Rights Reserved

Consumer Choice Theory is important in

Microeconomics All Rights Reserved

Theory of Utility: Satisfaction received by the

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Total utility (TU) is the total satisfaction

Microeconomics All Rights Reserved

Change in Total Utility

Microeconomics All Rights Reserved

Based on the table above, MU of the 1st unit is

Microeconomics All Rights Reserved

This law states that the marginal utility

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

In this approach, the satisfaction received by

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

Certain goods are perfect subsitutes in

Microeconomics All Rights Reserved

This is a set of basket that a

Microeconomics All Rights Reserved

By combining the indifference curve and

Microeconomics All Rights Reserved

This is a situation in which a particular good

Microeconomics All Rights Reserved

A change in income will affect consumption

Microeconomics All Rights Reserved

These are goods where the consumer

Microeconomics All Rights Reserved

These are goods where consumption is

Microeconomics All Rights Reserved

Changes in price would affect the market

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

This is the net benefit or gain secured

Microeconomics All Rights Reserved

Microeconomics All Rights Reserved

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