Chapter 6:

Consumer Behaviour
Chapter Outline/Learning Objectives

Section Learning Objectives

After studying this chapter, you will be able to

6.1 Marginal Utility 1. describe the difference between marginal

and Consumer Choice and total utility.

2. explain how utility-maximizing consumers

adjust their expenditure until the marginal utility
per dollar spent is equalized across products.
6.2 Income and 3. understand how the slope of any demand curve is
Substitution Effects determined by the income and substitution effects of
of Price Changes price changes.

6.3 Consumer Surplus 4. see that consumer surplus is the "bargain" the
consumer gets by paying less for the product
than the maximum price he or she is willing to pay.

5. explain the "paradox of value."

6.1 Marginal Utility and Consumer Choice

Utility is the satisfaction that a consumer receives from consuming

some good or service.

Total utility is the consumer’s total satisfaction resulting from the

consumption of a given product.

Marginal utility is the additional satisfaction obtained from

consuming one additional unit of a product.
6.1 Marginal Utility and Consumer Choice

Diminishing Marginal Utility

The utility that any consumer derives from successive units of a
particular product consumed over some period of time diminishes as
total consumption of the product increases (holding constant the
consumption of all other products).

Think about your total utility from water.

Initially, the utility you receive is high. As you use more and more
water, your marginal utility from each additional litre decreases.
Utility Schedules & Graphs
Fig. 6-1 Total and Marginal Utility

Bottles Alison's Alison's

Total Marginal
Utility Utility
0 0 30
1 30 20
2 50 15
3 65 10
4 75 8
5 83 6
6 89 4
7 93 3
8 96 2
9 98 1
10 99
Maximizing Utility

Consumers seek to maximize their total utility subject to the

constraints they face—their income and market price.

A utility-maximizing consumer allocates expenditures so that the

marginal utility obtained from the last dollar spent on each product is
equal.
Maximizing Utility

An example:

Consider Alison, whose utility from the last dollar spent on juice is
more than from the last dollar spent on burritos.

She increases her total utility by spending a dollar more on juice and
a dollar less on burritos.

She maximizes total utility when the marginal utility per dollar spent
on juice equals the marginal utility per dollar spent on burritos.
Maximizing Utility

For two products X and Y, the utility-maximizing condition is:

MUX MUY MUX pX

= or =
pX pY MUY pY

The right side of the second equation is the relative price of the two
products.
The Consumer's Demand Curve

What happens when there is a change in the product's price?

If the price of juice (X) rises, then at the previous utility-maximizing

point:

MUX pX
<
MUY pY

To restore the equality, the consumer reduces consumption of juice.

Why?
The Consumer's Demand Curve

The hypothesis of diminishing marginal utility tells us that as a

consumer buys less of a product, the marginal utility rises.

This leads to the basic prediction of demand theory:

A rise in the price of a product (with all other determinants of

demand held constant) leads each utility-maximizing consumer to
reduce the quantity demanded of the product.
Market Demand Curves

The theory of consumer behaviour predicts a negatively sloped

market demand curve as well as a negatively sloped demand
curve for each individual consumer.

Fig. 6-2 Market and Individual Demand Curves

6.2 Income and Substitution Effects of Price Changes

A change in price has two distinct effects—it alters the relative price
and it changes consumers' real income.

Real income is income expressed in terms of the purchasing power

of money income—that is, the quantity of goods and services that
can be purchased with the money income.
6.2 Income and Substitution Effects of Price Changes

The Substitution Effect

The substitution effect is the change in the quantity of a product

demanded resulting from a change in its relative price (holding real
income constant).

The substitution effect increases the quantity demanded of a

product whose price has fallen and reduces the quantity demanded
of a product whose price has risen.
The Income Effect

The income effect is the change in the quantity of a product

demanded resulting from a change in real income (holding relative
prices constant).

The income effect leads consumers to buy more of a product whose

price has fallen, provided that the product is a normal good.

The size of the income effect depends on the amount of income

spent on the product whose price changes and on the amount by
which the price changes.
The Slope of the Demand Curve

The substitution effect leads consumers to increase their demand for

all normal goods whose prices fall.

The income effect leads consumers to buy more of all normal goods
whose prices fall.

Because of the combined operation of the income and substitution

effects, the demand curve for any normal good will be negatively
sloped.

A fall in price will increase the quantity demanded.

Fig. 6-3 Income and Substitution Effects of a Price Change
6.3 Consumer Surplus

The Concept
Litres of Milk Amount Moira is Willing to Moira's Consumer Surplus If
Moira Consumes/Week Pay/Litre She Actually Pays $1/Litre
First $ 6.00 $ 5.00
Second 3.00 2.00
Third 2.00 1.00
Fourth 1.60 0.60
Fifth 1.20 0.20
Sixth 1.00 0.00
Seventh 0.80 --
Eighth 0.60 --
Ninth 0.50 --
Tenth 0.40 --
Fig. 6-4 Consumer Surplus on Milk Consumption

Consumer surplus on
each unit consumed is the
difference between the
market price and the
maximum price that the
consumer is willing to pay to
obtain that unit.
Consumer Surplus

Consumer surplus is the difference between the total value that

consumers place on all units consumed of a product and the
payment that they actually make to purchase that amount of the
product.

The area under the demand curve shows the total value a consumer
places on a good.

The market demand curve shows the valuation that consumers place
on each unit of the product.

For any given quantity, the area under the demand curve and above
the price line shows the consumer surplus received from consuming
those units.
Consumer Surplus
Total consumer
surplus is the area
Fig. 6-5 Consumer Surplus
under the demand for the Market
curve and above the
price line.
The area under the
curve shows the total
valuation that
consumers place on all
units consumed.
The Paradox of Value

Early economists and philosophers encountered the paradox of

value.

Why is it that water, which is essential to life, has a low price, while
diamonds, which are not essential to life, have a high price?

Early economists thought the price or “value” of a good depended

only on the demand by consumers.
The Paradox of Value

This view ignores two important aspects of the determination of

price.

1.Supply plays just as important a role as demand in determining

price.

2.Consumers purchase units of a good until the marginal value of the

last unit purchased is equal to its market price.

So water has a plentiful supply, and hence a low price; diamonds

have a relatively scarce supply and hence a high price.
Fig. 6-6 Resolving the Paradox of Value

Water has a high total value and a low price, which leads to a large
consumer surplus. Diamonds have a low total value and a high price,
which leads to a small consumer surplus.