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As long as scarcity exists, people will face
choices.
Economists assumed that consumer will
compare benefit and costs.
… and then make choices that will give

them the greatest overall well-being or net
benefit.
▪I couldn’t eat another bite.
▪I’ll never get tired of your cooking.
▪The last drop tastes as good as the
first.
▪I would never watch that movie
even if you pay me.
▪ What is behind a consumer’s demand
curve?
▪ How do consumers choose from among
various consumer “goods”?
▪ What determines the value of a
consumer good?
▪Consumer choice among various
alternatives is subject to
constraints:
▪income or budget
▪prices of goods purchased
▪preferences
4
In economics the satisfaction or
pleasure consumers derive from the
consumption of consumer goods is
called “utility”.
▪ Marginal Utility approach - cardinal
measure of utility
▪ Indifference approach - ordinal
utility
5
▪ Consumers are utility maximizers
▪ Consumers prefer more of a good (thing) to less of
it.
▪ Facing choices X and Y, a consumer would either
prefer X to Y or Y to X, or would be indifferent
between them.
▪ Transitivity: If a consumer prefers X to Y and Y to Z,
we conclude he/she prefers X to Z
▪ Diminishing marginal utility: As more and more of
good is consumed by a consumer, ceteris paribus,
beyond a certain point the utility of each
additional unit starts to fall.
Measuring utility in “utils” (Cardinal):
▪ Jack derives 10 utils from having one slice of
pizza but only 5 utils from having a burger.
Measuring utility by comparison

(Ordinal):
▪ Jill prefers a burger to a slice of pizza and a
slice of pizza to a hotdog.
❖Total utility is the total satisfaction a person
derives from consumption
❖Marginal utility is the change in total utility

resulting from a one-unit change in
consumption of a good
MU = Change in Total Utility

Change in quantity
TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
consumed Utility, Utility, 30
Total Utility (utils)

per meal Utils Utils
20
0 0
1 10 10
0 1 2 3 4 5 6 7
Units consumed per meal
Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
0 1 2 3 4 5 6 7

10
8
6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
8
2 18
0 1 2 3 4 5 6 7

10
8
6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7
4
4 28

10
2 8
5 30 6
0 4
6 30 2
0
-2
1 2 3 4 5 6 7
Tacos Total Marginal TU

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7
4
4 28

10
2 8
5 30 6
0 4
6 30 2
-2 0
7 28 -2
1 2 3 4 5 6 7
MU
Tacos Total Marginal TU

0 0
20
Observe
10 Diminishing
1 10 10
8
2 18 Marginal
6
3 24 0 1
Utility
2 3 4 5 6 7
4
4 28

10
2 8
5 30 6
0 4
6 30 2
-2 0
7 28 -2
1 2 3 4 5 6 7
MU
▪ When MU is positive and increasing, TU will
increase at an increasing rate.
▪ When MU is positive but decreasing, TU will

increase at a decreasing rate.
▪ If MU is negative, TU will decrease.

TABLE 6.2 TOTAL UTILITY AND MARGINAL FIGURE 6.3 Graphs of Frank’s Total
UTILITY OF TRIPS TO THE CLUB PER WEEK and Marginal Utility
Trips Total Marginal

to Club Utility Utility
1 12 12
2 22 10
3 28 6
4 32 4
5 34 2
6 34 0
Marginal utility is the additional
utility gained by consuming one
additional unit of a
commodity—in this case, trips
to the club.
When marginal utility is zero,
total utility stops rising.
Copyright © 2017 Pearson Education, Inc. 6-16

▪ Because we use money (rather than
hotdogs!) in just about all of our trade
transactions, we might as well use it
as our comparative measure of utility.
(Note: This way of measuring utility is
not much different from measuring
utility in utils)
THEORY OF CONSUMER BEHAVIOR
Utility Maximizing Rule
The consumer’s money income
should be allocated so that the
last dollar spent on each product
yields the same amount of extra
(marginal) utility.
❖Consumer equilibrium is achieved when the
budget is completely spent and the last dollar
spent on each good yields the same utility
MUp MUv
=
Pp Pv
❖Where MUp is the marginal utility of pizza, pp is
the price of pizza, MUv is the marginal utility of
videos, and pv the price of videos
UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)
First 10 10 24 12
How should the $10

income be allocated?
Marginal Marginal
First 10 10 24 12
Examine the two

marginal utilities
Marginal Marginal
First 10 10 24 12
Examine the two

marginal utilities
…per dollar
Marginal Marginal
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
Sixth 4 4 6 3
Seventh 3 3 4 2
Algebraic Restatement of the

Utility Maximization Rule
MU of product A MU of product B
Price of A
= Price of B
8 Utils 16 Utils
$1
= $2
UTILITY MAXIMIZATION AND
THE DEMAND CURVE
Deriving the Demand Schedule
and Curve
Create a demand schedule from the
purchase decisions as the price of
the product is varied ...
Price per unit of B Quantity Demanded
$2 4
1 6
Graphically…
UTILITY MAXIMIZATION AND
THE DEMAND CURVE
Deriving the Demand Schedule
and Curve
Price per unit of Good B

$2
DB
0
4 6
Quantity Demanded of Good B
ALLOCATING INCOME TO MAXIMIZE UTILITY
TABLE 6.3 Allocation of Fixed Expenditure per Week between Two Alternatives
(1) Trips to Club (2) Total Utility (3) Marginal (4) Price (P) (5) Marginal Utility per
per Week Utility (MU) Dollar (MU/P)
1 12 12 $3.00 4.0
2 22 10 3.00 3.3
3 28 6 3.00 2.0
4 32 4 3.00 1.3
5 34 2 3.00 0.7
6 34 0 3.00 0
(1) Basketball (2) Total Utility (3) Marginal (4) Price (P)
Games per Week Utility (MU) (5) Marginal Utility
per Dollar (MU/P)
1 21 21 $6.00 3.5
2 33 12 6.00 2.0
3 42 9 6.00 1.5
4 48 6 6.00 1.0
5 51 3 6.00 0.5
6 51 0 6.00 0
DIMINISHING MARGINAL UTILITY AND DOWNWARD-
SLOPING DEMAND
FIGURE 6.4 Diminishing Marginal Utility and
Downward-Sloping Demand
▪ At a price of $40, the utility gained from
even the first Thai meal is not worth the
price.
▪ However, a lower price of $25 lures Ann

and Tom into the Thai restaurant 5 times a
month. (The utility from the sixth meal is
not worth $25.)
▪ If the price is $15, Ann and Tom will eat

Thai meals 10 times a month—until the
marginal utility of a Thai meal drops
below the utility they could gain from
spending $15 on other goods.
▪ At 25 meals a month, they cannot tolerate

the thought of another Thai meal, even if it
is free.
❖ Suppose that we have the following bits of
information
❖ The price of movie pass is $8
❖ The price of ramen is $4
❖ Budget is $40 per week
1. List all combinations that will allow the
consumer to attain equilibrium. Compute for
their costs. Encircle the combination he will
choose.
2. Answer the same questions again suppose price
of movie pass fell to $6.
3. Derive the demand for movie pass of this
consumer.
Q of Movie Q of Ramen
(price=$8) TU MU MU/P (price=$4) TU MU MU/P
(1) (2) (3) (4) (5) (6) (7) (8)
0 0 - - 0 0 -
1 56 1 40
2 88 2 68
3 112 3 88
4 130 4 100
5 142 5 108
6 150 6 114
(1) (2) (3) (4) (5) (6) (7) (8)
0 0 - - 0 0 - -
1 56 56 7 1 40 40 10
2 88 32 4 2 68 28 7
3 112 24 3 3 88 20 5
4 130 18 2¼ 4 100 12 3
5 142 12 1½ 5 108 8 2
6 150 8 1 6 114 6 1½
(1) (2) (3) (4) (5) (6) (7) (8)
0 0 - - 0 0 - -
1 56 56 9 1/3 1 40 40 10
2 88 32 5 1/3 2 68 28 7
3 112 24 4 3 88 20 5
4 130 18 3 4 100 12 3
5 142 12 2 5 108 8 2
6 150 8 1 1/3 6 114 6 1½
MUX> MUY says that the marginal utility of an additional
PX PY
dollar spent on good X is greater than that of
a dollar spent on good Y.
MUX< MUY indicates that the MU per dollar spent on good
PX PY Y exceeds that of a dollar spent on good X.
If the amount spent on the two goods is equal to the budget
then MU > MU
X Y suggests that the individual should buy
PX PY less of Y in order to buy more of X.
MUX< MUY says to purchase less X to pay for additional
PX PY
amounts of Y.
MUX= MUY
is an equilibrium condition!
PX PY
Sample Application
Suppose a BMW costs approximately $30,000
and a Honda Civic costs $15,000. Jason would
get 10,000 units of satisfaction from the Civic
and 15,000 units of satisfaction from the BMW.
Assuming Jason could afford either vehicle,
which should he buy?
Answer: The Civic. Why?
Because when we apply the equi-marginal

principle, we see that
15,000/ 30,000 (BMW) < 10,000/ 15,000 (Civic)
INDIFFERENCE CURVE
ANALYSIS
▪ Indifference curves
An indifference curve is a line drawn in a two-
dimensional space showing different
combinations of two goods from which the
consumer draws the same amount of utility and
therefore he/she is “indifferent” about.
▪ Budget lines
A budget line is a line drawn in a two-
dimensional space representing a certain level of
income with which the consumer can purchase
various combinations of two goods at given
prices.
How do we get an understanding of consumer preferences? We observe what
they do!
Television A Television B
Cost = $500 Cost = $2500
Suppose you walk into the store with a choice between two TVs.
Suppose that you Either you prefer Television A or you can’t

choose Television A afford Television B
Suppose that you

You must prefer Television B
choose Television B
Suppose that you observed the following consumer behavior
P(Bananas) = $4/lb. Q(Bananas) = 10lbs

Choice A
P(Apples) = $2/Lb. Q(Apples) = 20lbs
P(Bananas) = $3/lb. Q(Bananas) = 15lbs

Choice B
What can you say about this consumer?
Is strictly
Choice B Choice A
preferred to
How do we know this?

Consumers reveal their preferences through their observed choices!
Choice A Choice B
Q(Bananas) = 10lbs Q(Bananas) = 15lbs

Q(Apples) = 20lbs Q(Apples) = 15lbs
P(Bananas) = $4/lb.
Cost = $80 Cost = $90
P(Apples) = $2/Lb.
P(Bananas) = $3/lb.
Cost = $90 Cost = $90
P(Apples) = $3/Lb.
B Was chosen even though A was the same price!

What about this choice?
Choice C
P(Bananas) = $2/lb. Q(Bananas) = 25lbs Cost = $90
Q(Bananas) = 15lbs Cost = $90

Choice B
Q(Apples) = 15lbs
Q(Bananas) = 10lbs Cost = $100

Choice A
Q(Apples) = 20lbs
Is strictly Is choice C preferred

Choice C Choice B
preferred to to choice A?
Is strictly
Choice B Choice A
preferred to
Is strictly
Choice C Choice B
preferred to
C>B>A
Is strictly
Choice C Choice A
preferred to
Rational preferences exhibit transitivity

Consumer theory begins with the assumption that every consumer has
preferences over various combinations of consumer goods. Its usually
convenient to represent these preferences with a utility function
U :A→ B
U
A B
Set of possible
“Utility Value”
consumption choices
Using the previous example (Recall, C > B > A)
Choice A
Q(Bananas) = 10lbs
Q(Apples) = 20lbs
Choice B
Q(Bananas) = 15lbs U (25,10)  U (15,15)  U (10,20)
Q(Apples) = 15lbs
Choice C
Q(Bananas) = 25lbs
Q(Apples) = 10lbs
We require that utility functions satisfy a few basic properties
There is a definite ranking of all

choices (i.e. transitivity)
y U (C )  U ( A)
U ( A) = U ( B )
U (C )  U (B )
A
C
U ( x, y ) = 25
B U ( x, y ) = 20
x
This tells us that indifference curves can’t

cross on another
Suppose that indifference curves did cross…
We run into a problem!
y U (C )  U ( A)
U ( A) = U ( B ) U ( A)  U (C )
U (C ) = U (B )
C
U ( x, y ) = 20
B U ( x, y ) = 25
x
More is always better!

y
C
U (C )  U ( A)
B U ( x, y ) = 20
x
People Prefer Moderation!

y U (C )  U ( A)
15 A
C
10
U ( x, y ) = 25
5
B U ( x, y ) = 20
x
5 10 15
Note: This is a result of diminishing marginal utility…this guarantees that

demand curves slope down!
What if we didn’t have decreasing marginal utility?
People prefer extremes!

y U (C )  U ( A)
A
C
B
U ( x, y ) = 25
x
U ( x, y ) = 20
Increasing marginal utility produces some weird decisions!!

We can characterize preferences with a few statistics. First, how does a consumer
prefer one good relative to another.
Marginal Utility of X
y
y U x ( x* , y * )
= MRS = −
x U y ( x* , y * )
y*
y
Marginal Utility of Y
x U ( x, y ) = 20
x
x*
The marginal rate of substitution (MRS) measures the amount of Y you need
to be get in order to give up a little of X
▪ Indifference curves for two “goods” are generally
negatively sloped
▪ The slope of an indifference curve reflects the
degree of substitutability of two goods for one
another
▪ Indifference curves are generally convex,
reflecting the principle of diminishing returns
▪ Indifference curves never cross
▪ Indifference curves that are farther from the
origin represent higher levels of utility
▪ Indifference curves for a “good” and a “bad” are
positively sloped
INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
0 12 12
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
j 12 2
0
2 4 6 8 10 12
Quantity of B
INDIFFERENCE CURVES
What is Preferred
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
k
0 12 12
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
j 12 2
0
k 6 4 2 4 6 8 10 12
Quantity of B
INDIFFERENCE CURVES
What is Preferred
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
k
0 12 12 l
An Indifference 4
Schedule
m
Combi- Units Units
nation of A of B 2
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
INDIFFERENCE CURVES
What is Preferred
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
k
0 12 12 l
An Indifference 4
Schedule
m
Combi- Units Units
nation of A of B 2 I
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j The slope
12
represents
8 0 $12
10 the marginal
6 3 12
rate of substi-
4 6 12 8
Quantity of A
tution, (MRS)
2 9 12 6
k
0 12 12 l
An Indifference 4
Schedule
m
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
0 12 12
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
INDIFFERENCE CURVES
What is Preferred
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
We can characterize preferences with a few statistics. First, how does a consumer
prefer one good relative to another.
Marginal Utility of X
y
y U x ( x* , y * )
= MRS = −
x U y ( x* , y * )
y*
y
Marginal Utility of Y
x U ( x, y ) = 20
x
x*
The marginal rate of substitution (MRS) measures the amount of Y you need
to be get in order to give up a little of X
The marginal rate of substitution (MRS) measures the amount of Y you
require to give up a little of X
y MRS ( x* , y* )  MRS ( x' , y' )
If you have a lot of X relative to Y, then X is much

y* less valuable than Y MRS is low!
y' U ( x, y ) = 20
* x'
x
x
Elasticity of Substitution measures the degree in which you can alter the mix of
goods. Consider a couple extreme cases:
Perfect substitutes can always Perfect compliments have no

be can always be traded off in a substitutability and must me
constant ratio used in fixed ratios
Y Y
Elasticity is Infinite Elasticity is 0
X X
THE BUDGET LINE:
What is Attainable
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
0 12 12
4
0
2 4 6 8 10 12
Quantity of B
THE BUDGET LINE:
What is Attainable
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
0 12 12
4
0
2 4 6 8 10 12
Quantity of B
THE BUDGET LINE:
What is Attainable
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
2 9 12 6
0 12 12
4
0
2 4 6 8 10 12
Quantity of B
THE BUDGET LINE:
What is Attainable
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
(Unattainable)
2 9 12 6
0 12 12
4
2 (Attainable)
0
2 4 6 8 10 12
Quantity of B
THE BUDGET LINE:
What is Attainable
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8
Quantity of A
(Unattainable)
2 9 12 6
0 12 12
4
2 (Attainable)
0
2 4 6 8 10 12
Quantity of B
EQUILIBRIUM AT TANGENCY
Units of Units of
12
8 0 $12
10
6 3 12
4 6 12 8 (Unattainable)
Quantity of A
2 9 12 6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 (Attainable) I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
Equilibrium 12
occurs when
the consumer 10
selects the (Unattainable)
8
Quantity of A
combination
which reaches 6
the highest
4
attainable I4
I3
indifference 2 I2
(Attainable) I1
curve.
0
2 4 6 8 10 12
Quantity of B
What happens if the price of B
increases to $1.50?
The budget line
12
rotates reflecting
PriceB QuantityB 10 the reduction in
the quantity of B
$1.00 6 8
Quantity of A
units which is
6 attainable.
4
2 I3
0
2 4 6 8 10 12
Quantity of B
increases to $1.50?
The budget line
12
rotates reflecting
PriceB QuantityB 10 the reduction in
the quantity of B
$1.00 6 8
Quantity of A
units which is
1.50 3
6 attainable.
4
2 I3
By recording the I2
various quantities 0
demanded at the 2 4 6 8 10 12
various prices yields Quantity of B
the Demand schedule
DERIVING THE DEMAND CURVE
increases to $1.50?
Price of B Plotting the
Points yields the
PriceB QuantityB
Demand Curve
$1.00 6 $1.50
1.50 3
for Product B
1.00
By recording the DB
various quantities 0
demanded at the 2 4 6 8 10 12
various prices yields Quantity of B
the demand schedule.
Y
MRS = MUx/MUy= Px/Py

a
b
c
U4
U3
d U2
e U1
X
O
Y
a
b
Y1 C’ U5
c
Yo c” U4
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U2
e
U1 X
O Xo X1
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As long as scarcity exists, people will face

… and then make choices that will give

Measuring utility by comparison

❖Marginal utility is the change in total utility

MU = Change in Total Utility

Total Utility (utils)

Units consumed per meal

Marginal Utility (utils)

Total Utility (utils)

Units consumed per meal

Marginal Utility (utils)

Total Utility (utils)

Units consumed per meal

Marginal Utility (utils)

Total Utility (utils)

Marginal Utility (utils)

Total Utility (utils)

Marginal Utility (utils)

Total Utility (utils)

Marginal Utility (utils)

▪ When MU is positive but decreasing, TU will

▪ If MU is negative, TU will decrease.

Trips Total Marginal

Copyright © 2017 Pearson Education, Inc. 6-16

How should the $10

Examine the two

Examine the two

Algebraic Restatement of the

Price per unit of Good B

▪ However, a lower price of $25 lures Ann

▪ If the price is $15, Ann and Tom will eat

▪ At 25 meals a month, they cannot tolerate

(1) (2) (3) (4) (5) (6) (7) (8)

(1) (2) (3) (4) (5) (6) (7) (8)

Answer: The Civic. Why?

Because when we apply the equi-marginal

Suppose that you Either you prefer Television A or you can’t

Suppose that you

P(Bananas) = $4/lb. Q(Bananas) = 10lbs

P(Bananas) = $3/lb. Q(Bananas) = 15lbs

What can you say about this consumer?

How do we know this?

Q(Bananas) = 10lbs Q(Bananas) = 15lbs

B Was chosen even though A was the same price!

P(Bananas) = $2/lb. Q(Bananas) = 25lbs Cost = $90

P(Apples) = $4/Lb. Q(Apples) = 10lbs

Q(Bananas) = 15lbs Cost = $90

Q(Bananas) = 10lbs Cost = $100

Is strictly Is choice C preferred

Rational preferences exhibit transitivity

There is a definite ranking of all

This tells us that indifference curves can’t

We run into a problem!

More is always better!

People Prefer Moderation!

Note: This is a result of diminishing marginal utility…this guarantees that

People prefer extremes!

Increasing marginal utility produces some weird decisions!!

y MRS ( x* , y* )  MRS ( x' , y' )

If you have a lot of X relative to Y, then X is much

Perfect substitutes can always Perfect compliments have no

Elasticity is Infinite Elasticity is 0

MRS = MUx/MUy= Px/Py

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