T H EO RY O F

CONSUMER
B E H AV I O R - I
LECTURE 6
LEARNING OUTCOME
• LO1 Define and explain the relationship between total utility,
marginal utility, and the law of diminishing marginal utility

• LO2 Explain how a demand curve can be derived by observing the

outcomes of price changes in the utility-maximization model

• LO3 Discuss the exceptions/Limitations of Law of Diminishing

Marginal Utility

• LO4 Discuss the Importance of Law of Diminishing Marginal Utility

CONSUMER CHOICES
THE THEORY OF CONSUMER
BEHAVIOR
• The principle assumption upon which the theory of consumer
behavior and demand is built is: a consumer attempts to allocate
his/her limited money income among available goods and services so
as to maximize his/her utility (satisfaction).

• Walters defines consumer behavior as: " ... the process whereby
individuals decide whether, what, when, where, how, and from whom
to purchase goods and services."
 CONSUMER BEHAVIOR
• CONSUMER BEHAVIOR is the study of
individuals, groups, or organizations
and the processes they use to select,
secure, use, and dispose of products,
services, experiences, or ideas to
satisfy needs and the impacts that
these processes have on the
consumer and society.
 LAW OF DIMINISHING MARGINAL
UTILITY
• For example durable goods. A
consumer’s desire for an automobile,
when he or she has none, may be
very strong. But the desire for a
second car is less intense; and for a
third or fourth, weaker and weaker.
Unless they are collectors, even the
wealthiest families rarely have more
than a half-dozen cars, although
their incomes would allow them to
purchase a whole fleet of vehicles.
UTILITY
• Utility is want-satisfying power. The utility of a good or service is the
satisfaction or pleasure one gets from consuming it.

• The value a consumer places on a unit of a good or service depends on the

pleasure or satisfaction he or she expects to derive form having or
consuming it at the point of making a consumption (consumer) choice.

• In economics the satisfaction or pleasure consumers derive from the

consumption of consumer goods is called “utility”.

• Consumers, however, cannot have every thing they wish to have.

Consumers’ choices are constrained by their incomes.

• Within the limits of their incomes, consumers make their consumption

choices by evaluating and comparing consumer goods with regard to their
“utilities.”
UTILITY CHARACTERISTICS
• The three characteristics are :
1. “Utility” and “usefulness” are not synonymous.
– Paintings by Picasso may offer great utility to art connoisseurs but are useless functionally
(other than for hiding a crack on a wall).

2. Utility is subjective. The utility of a specific product may vary widely

from person to person.
– A lifted pickup truck may have great utility to someone who drives off-road but little utility to
someone unable or unwilling to climb into the rig.

3. Utility is difficult to quantify. But for purposes of illustration we assume

that people can measure satisfaction with units called utils (units of
utility).
– For example, a particular consumer may get 100 utils of satisfaction from a smoothie, 10 utils
of satisfaction from a candy bar, and 1 util of satisfaction from a stick of gum. These
imaginary units of satisfaction are convenient for quantifying consumer behavior.
 THEORIES OF CONSUMER
BEHAVIOR
1. The Cardinal Utility Theory
– Utility is measurable in a cardinal sense
• cardinal utility - assumes that we can assign values for
utility, (Jevons, Walras, and Marshall). E.g., derive 100 utils
from eating a slice of pizza
2. The Ordinal Utility Theory
– Utility is measurable in an ordinal sense
• ordinal utility approach - does not assign values, instead
works with a ranking of preferences. (Pareto, Hicks, Slutsky)
HOW TO MEASURE UTILITY
Measuring utility in “utils” (Cardinal):
• Jack derives 10 utils from having one slice of pizza but only 5 utils from
having a burger.

• In many introductory microeconomics textbooks this approach to

measuring utility is still considered effective for teaching purposes.

Measuring utility by comparison (Ordinal):

• Jill prefers a burger to a slice of pizza and a slice of pizza to a hotdog.
• Often consumers are able to be more precise in expressing their
preferences.
• For example, we could say:
• Jill is willing to trade a burger for four hotdogs but she will give up only two
hotdogs for a slice of pizza.
• We can infer that to Jill, a burger has twice as much utility as a slice of
pizza, and a slice of pizza has twice as much utility as a hotdog.
THE
CARDINAL
APPROACH
 THEORY OF CONSUMER
BEHAVIOR-ASSUMPTIONS
• For simplicity, we will assume that the situation for the typical consumer
has the following dimensions.
1. Rational behavior -The consumer is a rational person, who tries to
use his or her money income to derive the greatest amount of satisfaction,
or utility, from it. Consumers want to get “the most for their money” or,
technically, to maximize their total utility.
2. Preferences - Each consumer has clear-cut preferences for certain of
the goods and services that are available in the market. Buyers also have a
good idea of how much marginal utility they will get from successive units
of the various products they might purchase.
THEORY OF CONSUMER
BEHAVIOR-ASSUMPTIONS

3. Budget constraint - At any point in time the consumer has a fixed,

limited amount of money income. Since each consumer supplies a
finite amount of human and property resources to society, he or she
earns only limited income.
4. Prices Goods - are scarce relative to the demand for them, so
every good carries a price tag. We assume that the price of each good
is unaffected by the amount of it that is bought by any particular
person.
LAW OF DIMINISHING MARGINAL
UTILITY

Law of Diminishing Marginal Utility (Return)  

• As more and more of a good are consumed, the process of consumption
will (at some point) yield smaller and smaller additions to utility
• Over a given consumption period, the more of a good a consumer has, or
has consumed, the less marginal utility an additional unit contributes to his
or her overall satisfaction (total utility).

• Alternatively, we could say: over a given consumption period, as more and

more of a good is consumed by a consumer, beyond a certain point, the
marginal utility of additional units begins to fall.
 TOTAL UTILITY AND MARGINAL
UTILITY
• Total utility and marginal utility are related, but different, ideas.
• Total utility is the total amount of satisfaction or pleasure a
person derives from consuming some specific quantity—for
example, 10 units—of a good or service.
• Marginal utility is the extra satisfaction a consumer realizes
from an additional unit of that product—for example from the
eleventh unit.
• Alternatively, marginal utility is the change in total utility that
results from the consumption of 1 more unit of a product.
MU = ΔTU/ΔQ
• It explains downward sloping demand.
TOTAL UTILITY AND MARGINAL
UTILITY

• When the total utility

maximum, marginal utility = 0

• When the total utility begins to
decrease, the
marginal utility = negative (-ve)
TOTAL AND MARGINAL UTILITY FOR
ICE CREAM
Q TU ($) MU ($)
0 0
1 40
2 85
3 120
4 140
5 150
6 157
7 160
8 160
9 155
10 145
 TOTAL UTILITY AND MARGINAL UTILITY
Total Utility

(1) (2) (3) 30

TU

Total Utility (Utils)

Tacos Total Marginal
Consumed Utility, Utility,
Per Meal Utils Utils 20

0 0] 10 10
1 10 ] 8
2 18 ]
6 0
3 24 ] 1 2 3 4 5 6 7
4
Marginal Utility (Utils)
28
4
] 2
10
5 30
] 0 8
6 30
] -2
6
4
7 28
2
0
-2
1 2 3 4 5 6 7MU

LO1 6-18
EXCEPTIONS OR LIMITATIONS
• The limitations or exceptions of the law of diminishing
marginal utility are as follows:
1. The law does not hold well in the rare collections. For
example, collection of ancient coins, stamps etc.
2. The law is not fully applicable to money. The marginal
utility of money declines with richness but never falls to
zero.
3. It does not apply to the knowledge, art and innovations.
4. The law is not applicable for precious goods.
EXCEPTIONS OR LIMITATIONS
5. Historical things are also included in exceptions to the
law.
6. Law does not operate if consumer behaves in irrational
manner. For example, drunkard is said to enjoy each
successive unit more than the previous one.
7. Man is fond of beauty and decoration. He gets more
satisfaction by getting the above merits of the commodities.
8. If a dress comes in fashion, its utility goes up. On the
other hand its utility goes down if it goes out of fashion.
IMPORTANCE OF THE LAW OF
DIMINISHING MARGINAL UTILITY
•The importance or the role of the law of diminishing marginal
utility is as follows:
1. By purchasing more of a commodity the marginal utility
decreases, due to this behavior, the consumer cuts his
expenditures to that commodity.
2. In the field of public finance, this law has a practical
application, imposing a heavier burden on the rich people.
3. This law is the base of some other economic laws such as law
of demand, elasticity of demand, consumer surplus and the law
of substitution etc.
4. The value of commodity falls by increasing the supply of a
commodity. It forms a basis of the theory of value. In this way
prices are determined
 DEMAND

By changing the price of the good [in this case, good X]

and holding all other variables [PY , budget or income and

preferences] constant, the demand for the good can be

mapped.
The demand function
is a schedule of the PX
quantities that individuals are
willing and able to buy at a 5
schedule of prices during a 4
De
specific period of time, 3 m
an
ceteris paribus. 2 d
1
1 2 3 4 5 6 7 QX/ut
A NEGATIVE SLOPE DEMAND CURVE AND
INCOME AND SUBSTITUTION EFFECTS

Income effect: As the price of a good that you buy increases

and money income is held constant, your real income
decreases and you can not afford to buy as much as you could
before. PX

Substitution effect: As
the price of one good rises 5
relative to the prices of 4
other goods, you will tend
3
to substitute the good De
that is relatively cheaper 2 m
an
d
for the good that is 1
relatively more expensive.
1 2 3 4 5 6 7 QX/ut
HOMEWORK:
• Complete the following table and answer the questions below:

Quantity Total Utility Marginal Utility

1 15
2 28
3 39
4 48
5 55
6 60
7 63
8 64
9 63
10 61

a) Graphically show Law of Diminishing Marginal Utility

b) Graphically explain Total Utility and Marginal Utility relationship