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Chapter 6:
Elasticity

ECO1001 Chapter 7
The theory of demand: the utility
approach
 Learning outcomes
Once you have studied this chapter you should be able to
• define utility, marginal utility and weighted marginal
utility
• explain the relationship between total, average and
marginal values
• state the conditions for consumer equilibrium
• use weighted marginal utility to derive a demand curve

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 Utility

• Utility is simply a term for consumer satisfaction.

• the degree of satisfaction derived from the consumption of a good or service.
• maximisation of utility given alternative consumption possibilities.

• Cardinal utility
• involves the idea that utility can be measured in some way.

• Ordinal utility
• involves the ranking of different bundles of consumer goods or services in order of
preference.

• The utility approach to the analysis of consumer behaviour is based on the assumption
that a consumer can assign values to the amount of satisfaction (utility) that he or she
obtains from the consumption of each successive unit of a consumer good or service.
• Based on the notion of cardinal utility.

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 Marginal utility and total utility
Box: Total, average and marginal magnitudes

Table: marginal utility and total utility from the consumption of

apples during a specific period

• Marginal utility - utility that a consumer

derives from the consumption of one
additional unit of a good or service.

• Total utility is the sum of all the marginal

utilities.

• Negative utility is usually called disutility.

• Law of diminishing marginal utility states

that the marginal utility of a good or
service eventually declines as more of it
is consumed during any given period.
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 Consumer equilibrium in the utility
approach

• Utility theory
• Assumption – consumers max utility
• However, resources constraints limits capacity to satisfy wants.
• Aim - highest attainable level of total utility
• A consumer will be in equilibrium if he or she obtains the
maximum possible total utility.
• Assumption – consumers are aware of their wants and of the
utility they will derive from satisfying these wants.
• Scale of preference.

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 Consumer equilibrium in the utility approach

• Weighted marginal utility is the marginal utility per unit divided by the
price per unit (MU/P).

Table: Winnie’s scale of preferences in respect of the weekly consumption of

bread, meat and rice

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 Consumer equilibrium in the utility approach

• TWO conditions for equilibrium

1. The combinations of goods purchased has to be affordable (budget
constraints)
2. The Weighted marginal utility of the various good must be EQUAL

• Law of equalising the Weighted marginal utilities.

𝑀𝑈𝑎 𝑀𝑈𝑏
• =
𝑃𝑎 𝑃𝑏

𝑀𝑈𝑎 𝑃𝑎
• =
𝑀𝑈𝑏 𝑃𝑏

• Therefore the ratio of marginal utilities must equal (be the same as)
the ratio between market prices of the goods.
• If ratio is unequal, market disequilibrium, utility NOT maximised.

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 Consumer equilibrium in the utility approach

Table: Possible combinations of bread, meat and rice that can be

bought with R12,00 and the total utility of each combination

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 Derivation of an individual demand
curve for a product

Table Helen’s utility from chocolates and yoghurt (per week)

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 Derivation of an individual demand
curve for a product

• Suppose that Helen has R10,00 available per week to spend on chocolates
and yoghurt, which cost R2,00 and R3,00 per unit respectively. Her scale of
preferences is illustrated in below (next slide),
1. The combinations of goods purchased has to be affordable (budget
constraints)
2. The Weighted marginal utility of the various good must be EQUAL

• Law of equalising the Weighted marginal utilities.

𝑀𝑈𝑎 𝑀𝑈𝑏
• =
𝑃𝑎 𝑃𝑏

𝑀𝑈𝑎 𝑃𝑎
• =
𝑀𝑈𝑏 𝑃𝑏

• Therefore the ratio of marginal utilities must equal be the same as

the ratio between market prices of the goods.
• If ratio is unequal, market disequilibrium, utility NOT maximised.
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 Derivation of an individual demand curve for a product

Table Helen utility from the weekly consumption of chocolates

and yoghurt at a lower price of chocolates

Box Possible exceptions to the law of demand

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 Derivation of an individual demand curve for a product

Figure Helen’s demand curve for chocolates

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 Important concepts
• Utility
• Cardinal utility
• Ordinal utility
• Total utility
• Marginal utility
• Average utility
• Consumer equilibrium
• Substitution effect
• Income effect
• Snob effect
• Bandwagon effect
• Conspicuous consumption
• Inferior goods
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