The Theory

of
ConsumerBehavior

1
Utility concepts
Utility

…is the want satisfying power of a

good or service
Ordinal utility – ranking according to preference
Cardinal utility – assign “utils” to a given product

2
Utility concepts
Total Utility (TU)
overall level of satisfaction

Marginal Utility (MU)

additional satisfaction derived from
consuming an additional unit
MU = change in TU
change in Q

3
A closer look
Schedule of total utility (TUx) and marginal utility
(MUx) of a student for product X
TU,
Qx TUx MUx MU 35
0 0 -- 30
1 20 20 25
2 27 7 20
3 32 5 15
4 35 3 10

5 35 0 5

6 34 -1 0
4
0 1 2 3 4 5 6 Qx
Diminishing Marginal Utility

… as more and more of a good is

consumed, additional satisfaction
becomes less and less

5
Consumer Equilibrium
Equi-marginal principle (Utility approach)

Marginal utility derived from the last peso spent on a

product is equal to the marginal utility derived from
the last peso spent on another product

6
Consumer Equilibrium
Mathematically, consumer
equilibrium in a two-good
world requires

MUx = MUy
Px Py
Subject to:

I = QxPx + QyPy
7
An example
Marginal utilities per peso worth of fishballs (F) and siomai (S)
Q TUF MUF MUF/ TUS MUS MUS/
PF PS
1 30 30 15 50 50 5
2 39 9 4.5 105 55 5.5
3 45 6 3 148 43 4.3
4 50 5 2.5 178 30 3
5 54 4 2 198 20 2
6 56 2 1 213 15 1.5

8
PF = 2 PS = 10 I = P 60
An example
Marginal utilities per peso worth of fishballs (F) and siomai (S)
Q TUF MUF MUF/ TUS MUS MUS/
PF PS
1 30 30 15 50 50 10
2 39 9 4.5 105 55 5.5
3 45 6 3 148 43 4.3
4 50 5 2.5 178 30 3
5 54 4 2 198 20 2
6 56 2 1 213 15 1.5

9
PF = 2 PS = 10 I = P 60
Consumer Equilibrium
MUx = MUy
Px Py

Thus, two combinations satisfy the equi-marginal

condition

3QF + 4QS; and, 5QF + 5QS

However,
I = QxPx + QyPy must also be satisfied
10

Therefore, only 5 Fishballs and 5 siomai will

Consumer Equilibrium

Since I = QxPx +QyPy

Then, 3 (2) + 4 (10) = P46

X

Only 5 (2) + 5 (10) = P60

√

Consumer will be at his equilibrium 11

Income and Substitution
Effect: Revisited

Income effect (of a price change)

… is the impact on quantity demanded on a

change in purchasing power

Substitution effect (of a price change)

… is the impact of a pure price change on the

quantity demanded of a certain commodity 12
Consumer Equilibrium

Indifference curve approach

…consumers state their preferences by
just ranking bundles or combinations of
goods according to utility received from
these

13
Consumer Equilibrium

Indifference curve

 downward sloping
 convex to the origin
 does not intersect with each other
 higher one means higher level of
satisfaction

14
Indifference Curve

X
15
Indifference Curve
Y
X Y
25
1 25
20
2 19 15

3 15 10

4 12 5

5 10
0 1 2 3 4 5 X 16
Indifference Curve
Y
X Y
25
1 25
20
2 19 15

3 15 10

4 12 5

5 10
0 1 2 3 4 5 X 17
Indifference Curve
Y
X Y
25
1 25
20
2 19 15

3 15 10

4 12 5

5 10
0 1 2 3 4 5 X 18
Indifference Curve
Y
X Y
25
1 25
20
2 19 15

3 15 10

4 12 5

5 10
0 1 2 3 4 5 X 19
Indifference Curve
Y
X Y
25
1 25
20
2 19 15

3 15 10

4 12 5

5 10
0 1 2 3 4 5 X 20
Indifference Curve
Y
X Y
25
Indifference
1 25 curve
20
2 19 15

3 15 10

4 12 5

5 10
0 1 2 3 4 5 X 21
Marginal Rate of Substitution
Y
X Y MRS
25
…The maximum amount of
1 25 ∆Y Y that a consumer is willing
20 to give up in order to
consume an additional unit
2 19 15
of X while maintaining the
same level of utility

3 15 10

4 12 5 ∆X
5 10 0 1 2 3 4 5 X
22
Marginal Rate of Substitution
Y MRS
X Y
25
---
1 25
20
-6
2 19 15
-4
3 15 10
-3
4 12 5

5 10 -2
0 1 2 3 4 5 X
23
 Budget Line
Y
Income X Y 30 Budget
(P=10) (P=2) Line
60 0 30 25

60 1 25 20
60 2 20 15
60 3 15
10
60 4 10
5
60 5 5
60 6 0 0 1 2 3 4 5 6 X
24
Indifference curve

Consumer Equilibrium

…point of tangency between

indifference curve and budget line

25
Consumer Equilibrium
Y
30

25
Point of
tangency
20

15

10 IC

5 BL

0 1 2 3 4 5 6 X
26
 Consumer Equilibrium
Y
30
At the point of
tangency 25
between the Point of
indifference curve 20 tangency
and the budget
line
15
MRS = Px/Py
and 10 IC
I = QxPx + QyPy
5 BL

0 1 2 3 4 5 6 X
27
 Consumer Equilibrium
Y
30

MRS = -Px/Py 25
and Point of
I = QxPx + QyPy 20 tangency

i.e.
MRS = bet -6&-4 15

-Px/Py = -10/2 = -5 10 IC

60 = 3(10) + 15(2) 5 BL

0 1 2 3 4 5 6 X
28
Deriving the Demand Curve
A
10 BL: PB = 1.00 BL: PB = 1.50
PA = 1.50
PB = 1.00
8
With
income of
= P12
6

4
IC2
2 IC1

0 2 4 6 8 10 12 B
29
Deriving the Demand Curve for Product B
due to Price Change

PB

1.50

1.00

0.50

0 2 4 6 8 10 12 B
30