Chapter 7

The theory of demand: the

utility approach
 Objectives
• Define utility, marginal utility and weighted
marginal utility
• Explain the relationship between total,
average and marginal values
• State the conditions of consumer
equilibrium
• Use weighted marginal utility to derive a
demand curve
 Key concepts
• Utility
• Cardinal utility
• Ordinal utility
• Marginal utility
• Weighted marginal utility
• Total, average and marginal values
• Diminishing marginal utility
• Consumer equilibrium
 An introductory overview
• Downward sloping demand curve

• Examine consumer behaviour

• Explain why demand curves slopes

downward
– Utility approach & indifference approach

• Simplification of reality (theory)

 Utility
• Economic activity
• Consumption = satisfy wants
• Households:
– Aim to maximise their satisfaction of wants
• Utility:
– Expresses the degree of satisfaction a
consumer derives from the consumption of a
good or service
– Consumer behaviour = maximisation of utility
 Utility
Cardinal The idea that utility can be
Utility measured in some way

Ranking of different combinations of

Ordinal
consumer goods and services in order
Utility of preference

• Consumer assigns values to the amount of

satisfaction
• Compare the utility of different goods and
services quantitatively = ordinal utility
 Marginal utility and total utility
• Assign units of value to the utility derived
from consumption of successive units of a
product
• Utils
• Utility is not constant
• Diminishing marginal utility
• Derives more satisfaction from first
consumption of a product
 MU and TU
ca

• Marginal utility Quantity Marginal Utility

– Extra or additional (utils)
utility a consumer 1 100
derives from the
consumption of
additional unit of a 2 70
good
3 20
• Example:
– Consumption of
4 0
chocolate cake
5 -4
 MU and TU
Quantity MU Total Utility

1 100 100

2 70 170

3 20 190

4 0 190

5 -4 186
 MU and TU
• MU declines until it reaches zero
• Then it becomes negative
- disutility

• Total Utility increases as long as Marginal

Utility is positive
• Maximum when MU = 0
• TU declines when MU becomes negative
 MU and TU
• MU = additional utility from additional
consumption
• TU = sum of all the marginal utilities

• Law of diminishing marginal utility

– The marginal utility of a good or service
eventually declines as more of it is consumed
during any given period
– Gossen’s first law
 Consumer equilibrium
• Consumer strives to obtain the highest
attainable level of total utility
• Consumer’s income and prices of goods
and services
• For a given income and a given set of
prices of goods and services, a consumer
will be in equilibrium if he/she obtains the
maximum possible total utility
 Consumer equilibrium
• Scale of preferences
• Example:
– Table 7-2
– Consumption of three goods

• Weighted marginal utility

– Marginal utility per unit divided by the price
per unit
– MU/P
 Consumer equilibrium
Budget of R27.00
Coke R2 Choc R3 Chips R1
Units MUcoke MU/P MUchoc MU/P MUchips MU/P
1 50 25 66 22 20 20
2 38 19 63 21 16 16
3 28 14 39 13 12 12
4 14 7 30 10 7 7
5 6 3 21 7 2 2
 Consumer equilibrium
• Determine at which the combinations are
affordable and at which of these
combinations the weighted marginal utility
(MU/P) is the same for all the goods

• Equilibrium Condition:
MUB/PB = MUM/PM = MUR/PR

• Marginal utility must be related to the

prices of goods and services consumed
 Consumer equilibrium
• Two conditions for consumer equilibrium:
– The combination of goods purchased has to
be affordable
– The weighted marginal utilities (MU/P) of the
different goods must be equal

• Law of equalising the weighted marginal

utilities
• Combination 7: (5xR1) + (1xR3) + (2xR2)
 Consumer equilibrium
• Consumer’s subjective valuation of goods
and services
• Objective valuation of the market must be
the same
• MUA/PA = MUB/PB → MUA/MUB = PA/PB
- The ratio of MU = The ratio between the market prices

• MUB/PB = MUM/PM
• MUB/MUM = PB/PM → (30/90) = (1/3)
0.33 = 0.33
 Individual demand curve
• How a consumer’s equilibrium changes if
the price of a product changes
• Table 7-4: Helen Meyer’s R10.00 budget
– Chocolates = R2.00 and Yoghurt = R3.00

• Purchases 2 chocolates and 2 yoghurts

• MUC/PC = MUY/PY → MUC/MUY = PC/PY

• MUC/MUY = PC/PY → (20/30) = (2/3)

0.67 = 0.67
 Individual demand curve
• Suppose the price of chocolates falls to
R1.00
• Table 7-5:
• Weighted marginal utility is now 10
• Total utility increases from 119 to 143 utils
• Ratio between marginal utilities is the
same is the ratio between prices of the
product