2nd Exam Coverage

Consumer Behavior microeconomics in general) into a rigorous

mathematical science.
The Development of Consumer Demand
Theory
Jeremy Bentham – The first major advance in
the development of consumer demand theory UTILITY
was provided by Jeremy Bentham in the late
Utility is another term for the satisfaction of
1700s. Bentham coined the term “Utility” about
wants and needs obtained from the
the satisfaction of wants and needs. He also
consumption of goods and services. Two
developed the notion that people are motivated
other economic terms that are also
by the desire to maximize utility. Bentham firmly
frequently used to capture this notion are
believed that utility was a measurable,
welfare and well-being. Whichever term is
quantifiable characteristic of a person, much like
used, the underlying concepts are the same.
height or weight.

TOTAL UTILITY
John Stuart Mill – The theoretical work
developed by Bentham was extended and Is simply a measure of the total satisfaction of
popularized by John Stuart Mill, whose father wants and needs obtained from the
James Mill was a contemporary and close friend consumption or use of a good or service. It is
of Bentham. The elder Mill introduced the often convenient to present the total utility
younger Mill to the thoughts and teaching of for a range of quantities in a table such as
Bentham at an early age. John Stuart Mill the one displayed on the next slide.
expanded and promoted these consumer
demand principles in several publications, MARGINAL UTILITY
including his book, Principles of Political
Is the additional utility, or extra satisfaction of
Economics, which was the dominant economic
wants and needs, obtained from the
textbook for several decades.
consumption or use of an additional unit of
good or service. Marginal utility is, in other
words, the extra satisfaction gained from an
William Stanley Jevons – A major
extra unit of goods and services.
improvement in consumer demand theory was
provided by William Stanley Jevons with the
notion of marginal utility. Jevons also developed
the rule of consumer equilibrium, stating that
Marginal utility is expressed as:
consumers purchase goods such that the ratio of
Marginal Utility = change in total utility
marginal utilities is equal to the ratio of prices.
change in quantity
Along the way, Jevons helped transform
consumer demand theory (as well as

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An Illustration of the Law of

Diminishing Marginal Utility.

UTILITY ANALYSIS

RIDES TOTAL MARGINAL

UTILITY UTILITY
0 0 ___
1 11 11
2 20 9
3 27 7
4 32 5
5 35 3
6 36 1
7 35 -1
8 32 -3

The Law of Diminishing Marginal Utility

The law of diminishing marginal utility
state that marginal utility or extra utility
obtained from consuming a good decrease as
the quantity consumed increases. In essence,
each additional good consumed is less
satisfying than the previous one. This law is
particularly important for insight into market
demand and the law of demand.
If each additional unit of a good is less
satisfying, then a buyer is willing to pay less. As
such, the demand price decline. This inverse
law of demand relation between demand price
and quantity demanded is a direct implication
of the law of diminishing marginal utility.
Budget Constraint
It is sometimes termed “budget line”,
it refers to the limit to expenditure imposed
by a cash-limited budget. It is often
represented as a straight line in geometrical
representations of a consumer’s choice
possibilities between two goods or services,
where it shows the limiting boundary of
combinations of purchases that are possible
with the budget. Often used in conjunction
with the indifference curve to indicate the
choice that would be made by a utility-
maximizing individual.

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Indifference Curve
Total
Units of A Units of B
Expenditure
 Indifference curve analysis relies on a Price= 1.50 Price= 1 In Pesos
relative ranking of preferences between two 8 0 12
goods rather than the absolute 6 3 12
measurement of utility (Utils) derived from 4 6 12
the consumption of a particular good. 2 9 12
0 12 12
 The indifference curve shows how
consumers would react to different
combinations of products. On the graph, a
2. A higher Indifference Curve Represents
quantity of one product appears on the y-
a Higher level of satisfaction. The
axis. Consumers would be equally satisfied
indifference curve that lies above and
at any point along a given curve, as each
point brings the same level of utility to that to the right of another indifference
consumer. The slope of the curve is referred curve represents a higher level of
to as the marginal rate of substitution. satisfaction.

Properties of indifference curves

1. Indifference Curve is are negatively sloped

indifference curve that must slope downward
from left to right. As the consumer increases the
consumption of commodity X, he has to give up
certain units of commodity Y in order to
maintain the same level of satisfaction.

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3. Indifference Curves are convex to

the Origin
Consumer surplus is the extra satisfaction
4. Indifference Curves Cannot Intersect each
received when purchasing goods and
services. Consumer surplus is a term used in
economics to express the difference
between how much a consumer paid for a
good or service and how much extra he
would have been willing to pay for that good
and services.

other

Consumer Sovereignty

Consumer sovereignty is an economic

philosophy that suggests consumer demand
drives business in free enterprise systems in
which companies typically have the right to
enter an industry and compete fairly. Under
consumer sovereignty, consumers dictate
which companies succeed by purchasing the
products and services they prefer.

Consumer Surplus

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 The short run is a period of time when

there is at least one fixed factor input.
This is usually the capital input such as
plants and machinery and the stock of
buildings and technology. In the short
run, the output of a business expands
when more variable factors of
production (e.g. labor, raw materials,
and components) are employed.

Long Run Production

 In the long run, all of the factors of
production can change giving a
business the opportunity to increase
the scale of operations. For example, a

Chapter 5 business may grow by adding extra

labor and capital to the production
process and introducing new
COST OF PRODUCTION technology into its operations.

Production Theory and

Cost Analysis
Production
 Production refers to the output of
goods and services produced by
businesses within a market. This
production creates the supply that
allows our needs and wants to be
satisfied. To simplify the idea of the
production function, economists
create a number of time periods for
analysis.
Short Run Production
Productivity
When economists and government
ministers talk about productivity, they
are referring to how productive labor is.
But productivity is also about other
inputs.
Productivity of the variable factor
labor and the law of diminishing
returns
In the example presented, the labor input
is assumed to be the only variable factor
by the firm. Other factor inputs such as

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PRODUCTION
STAGES capital are assumed to be fixed in
supply. The “returns” to adding more
labor to the production process are
STAGE 1
measured in two ways;
 The total product curve has a positive slope
 Marginal product is greater than average 1. Marginal product (MP) = Change in
product. The marginal product initially total output from adding one extra
increases, then decrease until it is equal to unit of labor
the average product at the end of stage I.
 The average product is positive, and the 2. Average product (AP) = Total output
average product curve has a positive slope divided by the total units of
employed
STAGE II
 The total product curve has a decreasing
positive slope. In other words, the slope
becomes flatter with each additional unit of
the variable input.
 Marginal product is positive, and the marginal
product curve has a negative slope. The
marginal product curve intersects the
horizontal quantity axis at the end of stage II. Diminishing Returns
 The average product is positive, and the
average product curve has a negative slope.  Diminishing returns is said to occur
The average product curve is at its peak at the when the marginal product of labor
onset of stage II. At this peak, the average start to fall.
product is equal to the marginal product.
 The law of diminishing returns
occurs because factors of
production such as labor and capital
STAGE III
inputs are not perfect substitute for
 Production is most obvious for the each other. This means that
marginal product curve but is also resources used in producing one
indicated by the total product curve. type of product are not necessarily
 The total product curve has a negative as efficient (or productive) when
slope. It has passed its peak and is heading
down. switched to the production of
 The marginal product is negative, and the another goods or service.
marginal product curve has a negative
slope. The marginal product curve has Cost of Production
intersected the horizontal axis and is
moving down.  Cost are defined as those expenses
 Average product remains positive, but the faced by a business when producing
average product curve has a negative a good or service for a market.
slope.

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Every business face cost and these Average Total Cost (ATC) is the cost per
must be recouped from selling unit of output produced.
goods and services at different ATC=TC/Output.
prices if a business is to make a
Marginal cost (MC) is defined as the
profit from its activities. In the short
change in total costs resulting from the
run, a firm will have fixed production
and of one extra unit of output.
variable costs of production. Total In other words, it is the cost of
cost is made up of fixed costs expanding
and production by a very small
variable costs. amount.
MC = change in TC/change in
Fixed Costs
Quantity
 These costs do not vary directly
with the level of output
Variable Costs
 Variable costs vary directly with
output, i.e. as production rises, a
firm will face higher total variable
costs because it needs to purchase
extra resources to achieve an
expansion of supply.
In the example, a business is assumed to have
fixed costs of P30,000 per month regardless of  TC = TFC + TVC
the level of output produced. The table shows  ATC = TC/Q
total fixed costs and average fixed costs.  MC = change in TC/change in

When we add variable costs into the equation,

we can see the total costs of a business.