Consumer Behaviour

Theory of Demand
N5 Economics Unit 1
 Introduction
• The Theory of Demand attempts to explain
consumer behaviour.
• Consumers gain satisfaction from consuming
goods and services.
• Economists call this satisfaction utility.
 Consumer Behaviour
Term Explanation

Utility This is the satisfaction gained from

consuming goods and services. We can
measure the satisfaction of a product by the
price people are willing to pay for it.
 Consumer Behaviour
Term Explanation

Marginal This is the satisfaction gained from

Utility consuming an extra unit of a good.
 Consumer Behaviour
Term Explanation

Total This is the total amount of satisfaction

Utility gained from consuming a product in a
period of time. Total utility is the sum
of all marginal utilities gained from
each unit consumed.
 Experiment
• https://www.youtube.com/watch?v=wSAhAby
cffQ
• https://www.youtube.com/watch?v=63rcdLeX
iU8
 The Law of Diminishing Marginal Utility states:

As a person consumes more of a good or service in a

certain period of time, the utility gained from each
extra unit (the marginal utility) decreases.

Total utility will continue to increase, although at a

decreasing rate, until a maximum is reached.

At this point there is no further satisfaction to be

gained from consuming more of the product, therefore
marginal utility will be zero.
This means that consumers will reach a point of
consumption when they maximise the utility
gained.
 Example
Using the price the consumer is prepared to pay as a
measure of utility:

Glass o f Banana Milkshake Marginal ut ilit y To t al ut ilit y

Fir st £2.00 £2.00
Second £1.80 £3.80
Thir d £1.50 £5.30
Four th £1.10 £6.40
 This is the same as saying that:
• if price were £2.00 the consumer would be willing to buy 1
banana milkshake because he gets £2 worth of utility

• if price were £1.80 the consumer would be willing to buy 2

banana milkshakes because he gets £2 worth of utility from
the first pint and £1.80’s worth from the second

• if price were £1.50 the consumer would be willing to buy 3

banana milkshakes.

• if price were £1.10 the consumer would be willing to buy 4

banana milkshakes.
Marginal utility of Total utility of banana
banana milkshakes milkshakes consumed
 This information can be converted
into a demand schedule:

Price Q uant it y de m ande d o f banana m ilkshake s

£2.00 1
£1.80 2
£1.50 3
£1.10 4
This demand schedule can then be plotted
in a graph to make a demand curve:
Demand for banana milk shakes

Glasses of banana milk shakes

Over to You
• Consolidate your knowledge and
understanding about the Law of Diminishing
Returns by completing the two provided
worksheets!
However, you probably consume
more than one thing at a time…….
 Rational Consumer Behaviour
• In Economics, consumers are assumed to want to maximise
their own economic welfare, sometimes referred to as utility.

• If we assume that consumers act rationally, this means they

will choose between different goods and services so as to
maximise utility.
 Rational Consumer Behaviour
So consumers will take into consideration:
• How much satisfaction they get from buying and then
consuming an extra unit of a good or service (marginal utility)
and the price that they have to pay to make this purchase

• The satisfaction derived from consuming alternative products

and the prices of alternatives goods and services
 Rational Consumer Behaviour
• The rule for maximizing utility given a set of prices and a
budget is straightforward;

• If the marginal utility per pound spent on good X is greater

that the marginal utility per pound spent of good Y, buy good
X.

• If the marginal utility per pound spent on good X is less that

the marginal utility per pound spent of good Y, buy good Y.

• Utility is maximized when the marginal utility per pound

spent is the same for all goods.
 So Diminishing Marginal Utility can also be used to
explain how a consumer will allocate resources.

Last penny Last Last

spent on penny penny
Good A = spent on = spent on
Good B Good C