UTILITY AND
CONSUMER
BEHAVIOR
Theory of customer demand
Introduction to Utility
Types of Utility
The Law of Diminishing Marginal Utility
Limitations of Marginal Utility Theory
Lesson Indifference Curves and Budget
Constraints
Outline Consumer Equilibrium
Income and Substitution Effects of Price
Change
Normal, Inferior, and Giffen Goods
Deriving the Demand Curve
Consumer Surplus
Introduction to Utility
Utility is defined as the satisfaction, pleasure, or
benefit that a consumer derives from consuming a
good or service.
Utility refers to the value or benefit a consumer
expects to derive from consuming a product or service,
often measured by how much it improves their well-
being or satisfaction.
Two main types
ORDINAL
CARDINAL
ORDINAL Rank-based
UTILITY
(Indifference Curve Approach)
Ordinal Utility assumes that utility
cannot be measured in exact terms
but can only be ranked in order of
preference. In other words,
consumers can say which goods or
services they prefer more or less,
but they cannot assign a specific
numerical value to the satisfaction or
benefit they derive from consuming
them.
Example of Ordinal utility
CARDINAL
UTILITY
(MARGINAL UTILITY APPROACH)
Quantification of Utility: In this
approach, utility is considered
measurable and can be expressed in
numerical terms (often in "utils"—a
hypothetical unit of measurement).
This allows economists to compare
levels of satisfaction between
different goods or services consumed
by the individual.
CARDINAL
UTILITY
EXAMPLE
A consumer might assign a utility of 10 units to consuming one apple
and 20 units to consuming two apples, implying that the second
apple gives 10 additional units of satisfaction. The key feature of
cardinal utility is that these numerical values are meaningful, and the
difference between them reflects the actual difference in
satisfaction.
CARDINAL
UTILITY
MARGINAL UTILITY - ADDITIONAL SATISFACTION
The core concept in the cardinal utility approach is marginal utility,
which is the extra utility or satisfaction gained from consuming an
additional unit of a good.
ΔTU is the change in total utility
ΔQ is the change in quantity
CARDINAL
ΔTU
UTILITY ΔQ
is the change in total utility
is the change in quantity
MARGINAL
UTILITY
EXAMPLE
If a person consumes 3 apples and their total utility is 30 utils, and
after consuming 4 apples, their total utility increases to 38 utils, the
marginal utility of the 4th apple is:
CARDINAL UTILITY
Twix Total Utility Marginal Utility
(Quantity) (TU) (MU)
1 8
2 15
3 20
4 23
5 25
CARDINAL UTILITY
Total
Econ Marginal Utility
knowledge
Classes (MU)
(TU)
1 10
2 18
3 24
4 28
5 30
The Law of
Diminishing Marginal
Utility
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The Law of
Diminishing
Marginal Utility
One of the key principles of the cardinal utility approach is
the law of diminishing marginal utility. This states that as a
consumer consumes more units of a good, the additional
satisfaction from each subsequent unit decreases.
The Law of
Diminishing
Marginal Utility
Textbook Explanation
Up to a point, the more of a commodity you consume, the greater will
be your total utility. However, as you become more satisfied, each
extra unit that you consume will prob- ably give you less additional
utility than previous units. In other words, your marginal utility falls,
the more you consume. This is known as the principle of diminishing
marginal utility.
The Law of Diminishing Marginal Utility
Indifference
Curves and
Budget
Constraints
Indifference Curve
An indifference curve represents all the
combinations of two goods that provide the
consumer with the same level of satisfaction or
utility. In other words, a consumer is "indifferent"
between the combinations of goods along the curve,
as they all give the same amount of happiness or
satisfaction.
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Indifference Curve
Textbook Deffinition
An indifference curve shows all the various
combinations of two goods that give an equal
amount of satisfaction or utility to a consumer.
Suppose that you have 4 combinations of apples and oranges that give
you the same satisfaction level. Let's say that each combination gives
you a total utility of 40 utils.
Total
Apples Oranges
Utility
4 6 40 utils
5 4 40 utils
6 2 40 utils
7 1 40 utils
Suppose that you have 4 combinations of apples and oranges that give
you the same satisfaction level. Let's say that each combination gives
you a total utility of 40 utils.
oranges
6
5
4
3
2
1
0
4 5 6 7
Apples
Indifference Curve
EXAMPLE
Indifference Curve
EXAMPLE
Bundle A and B are the same as both of
them give him the equal satisfaction. In
other words, point A gives as much utility
as point B to the individual. The consumer
will be satisfied at any point along the
curve assuming that other things are
constant.
Budget Constraints
TEXTBOOK
The budget line shows what combinations of
two goods you are able to buy, given (a) your
income available to spend on them and (b)
their prices.
ONLINE
Represents the consumer's budget, showing
the combinations of goods a consumer can
afford given their income and prices.
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BUDGET LINE
ORANGES
10
8 BUDGET LINE
6
4
2
0
0 1 2 3 4 5
Apples
BUDGET LINE
Consumer
Equilibrium
Marginal Utility Approach
Indifference Curve Approach
Consumer equilibrium is the
point where a consumer
Consumer gets the most satisfaction
Equilibrium from their budget by
choosing the best
combination of goods.
Consumer Equilibrium
Marginal Utility Indifference
Approach Curve Approach
Consumer equilibrium
Consumer equilibrium
occurs where the budget
occurs when the marginal
line is tangent to the
utility per dollar spent is
highest possible
equal for all goods.
indifference curve.
Marginal Utility
Approach
This condition ensures that the consumer is getting
the same additional satisfaction (marginal utility) per
unit of money spent on each good. If the marginal
utility per dollar spent is higher for one good
compared to another, the consumer will reallocate
their spending toward the higher utility-per-dollar
good until equilibrium is reached.
Marginal Utility
Approach
Understanding this approach
To achieve consumer equilibrium using the marginal utility
approach, the consumer will adjust their spending across
goods until the marginalUnderstanding
utility per dollar is equal for all goods.
this approach
In other words, the consumer should distribute their budget so
that:
Marginal Utility
Approach
Total Utility Marginal Utility (Roller
# Times Going
(Roller Coaster) Coaster)
1st 120
2nd 200
Understanding this approach
3rd 240
4th 272
5th 288
6th 292
Marginal Utility
Approach
Total Utility Marginal Utility (Roller
# Times Going
(Roller Coaster) Coaster)
1st 120 120
2nd 200 80
Understanding this approach
3rd 240 40
4th 272 32
5th 288 16
6th 292 4
Marginal Utility
Approach
# Times Total Utility Marginal Utility
Going (Go Kart) (Go Kart)
1st 30
2nd 50
Understanding this approach
3rd 66
4th 74
5th 78
6th 80
Marginal Utility
Approach
# Times Total Utility Marginal Utility
Going (Go Kart) (Go Kart)
1st 30 30
2nd 50 20
Understanding this approach
3rd 66 16
4th 74 8
5th 78 4
6th 80 2
Marginal Utility
Approach
# Times Marginal Utility Marginal Utility
Going (Roller Coaster) (Go Kart)
1st 120 30
2nd 80 20
Understanding this approach
3rd 40 16
4th 32 8
5th 16 4
6th 4 2
MARGINAL UTILITY
PER DOLLAR SPENT
The cost of a roller coaster ride is $4.
The cost of a go kart drive is $2.
Marginal Utility
Approach
# Times Marginal Utility MU/P (Price Marginal Utility MU/P (Price =
Going (Roller Coaster) = $4) (Go Karts) $2)
1st 120 30 15
2nd 80 20 10
Understanding this approach
3rd 40 16 8
4th 32 8 4
5th 16 4 2
6th 4 2 1
Marginal Utility
Approach
# Times Marginal Utility MU/P (Price Marginal Utility MU/P (Price =
Going (Roller Coaster) = $4) (Go Karts) $2)
1st 120 30 30 15
2nd 80 20 20 10
Understanding this approach
3rd 40 10 16 8
4th 32 8 8 4
5th 16 4 4 2
6th 4 1 2 1
QUESTION
If you only have $16,
what combination will maximizes your utility?
Marginal Utility
Approach
# Times Going MU/P (Price = $4) MU/P (Price = $2)
1st 30 15
2nd 20 10
Understanding this approach
3rd 10 8
4th 8 4
5th 4 2
6th 1 1
QUESTION
If you only have $16,
what combination will maximizes your utility?
ANS - Ride the roller coaster 3 times and the rockets 2 times
Consumer Equilibrium
INDIFFERENCE
CURVE
APPROACH
Indifference
Curve Approach
Consumer equilibrium is reached at the point of
tangency between the budget line and the highest-
attainable indifference
maximises total curve.
xConsumer equilibrium is reached at the point of tangency between the budget line and the highest-attainable indifference curve.
This combination
satisfaction with a given limited
This combination maximises total
satisfaction with a given limited
Indifference
Curve Approach
Consumer equilibrium, under the Indifference Curve
Approach, refers to the point where a consumer
maximizes their satisfaction (utility) given their
xConsumer equilibrium is reached at the point of tangency between the budget line and the highest-attainable indifference curve.
income or budget constraint. It is achieved when the
This combination maximises total
satisfaction with a given limited
consumer selects a combination of goods that lies on
the highest possible indifference curve, while still
being affordable within their budget constraint.
INDIFFERENCE
CURVE
An indifference curve represents all the
combinations of two goods that provide the
consumer with the same level of satisfaction or
utility. In other words, a consumer is "indifferent"
between the combinations of goods along the
curve, as they all give the same amount of
happiness or satisfaction.
THE BUDGET LINE
Represents the consumer's budget,
showing the combinations of goods a
consumer can afford given their income
and prices.
xConsumer equilibrium is reached at the point of tangency between the budget line and the highest-attainable indifference curve.
This combination maximises total
satisfaction with a given limited
INCOME AND
SUBSTITUTION
EFFECTS OF
PRICE CHANGE
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