Chapter 6: Demand and Consumer behavior
Reference: Paul A. Samuelson & William D. Nordhaus
Prepared by Dr. Tasqurun Nessa
• What do you mean by utility?
• To describe consumer behavior economists developed the
concept of utility.
• In a word utility means satisfaction. More specifically utility
refers to how consumers rank different goods and services.
For example if basket A has higher utility than basket B for
Tina, this ranking indicates that Tina prefers A over B.
• Two measures to determine utility:
• Cardinal utility : Cardinal utility measures the quantitative
difference between the situations. It is assumed that a
person can say that he gets utility equal to 15 units from the
consumption of the first unit of a commodity and 10 units
from the second unit of it.
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• Ordinal utility: Under ordinal utility, we rank in order.
Consumers need to determine their preference ranking
of commodities. A statement of ordinal utility such as
basket A is preferred to basket B.
• 5.2 What is Total utility and Marginal utility
• Guess that consuming the first unit of ice cream gives
us a certain level of utility. Now imagine the second
unit. Our total utility goes up, because the second unit
gives us some additional utility.
• Total utility: Total utility is the total satisfaction
received from consuming a given total quantity of a
good or service,
• Marginal utility: In Economics marginal means
additional or extra.
• Marginal utility denotes the additional utility that we
get from the consumption of an additional unit of a
good. 2
• Relationship of Total and Marginal utility
• Total utility of consuming a certain amount of is
equal to the sum of the marginal utilities. Using
table or graph we can easily explain the relation of
total and marginal utility.
• 5.3 The law of diminishing Marginal utility
• One of the fundamental ideas behind demand
theory is the law of diminishing marginal utility.
• The law of diminishing marginal utility says that the
amount of marginal utility declines when a person
consumes more and more of a good.
• This law states total utility increases as consumption
grows, but at a lower rate.
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Table5.1 Total utility and Marginal utility
Quantity of a Total utility Marginal utility
good consumed (in unit) (in unit)
1 4 4
2 7 3
3 9 2
4 10 1
5 10 0
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• Table 5.1 shows in column 1 quantity of a
good consumed, column 2 total utility and
column 3 marginal utility. When the individual
consumes 1 unit the total utility is 4 and
marginal utility is also 4. Marginal utility
measures the additional utility, when 1 extra
unit of good consumed. Thus, when the
individual consumes 2 units, the total utility is
7 and marginal utility is 7-4= 3 units. We can
see when the individual consumes 3 units, the
total utility is 9 and marginal utility is 9-7= 2
units.
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• After that when the individual consumes 4
units, the total utility is 9 and marginal utility is
10-9= 1 units. Lastly when the individual
consumes 5 units the total utility is 10 and
marginal utility is 10-10= 0 units.
• We see that the total utility is 10 units which is
the sum of the marginal utilities 4+3+2+1+0=10,
when 5 units is consumed.
• Focus on column 3, the fact that the marginal
utility declines with higher consumption
illustrates the law of diminishing marginal utility.
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• Criticism of the law of diminishing marginal utility:
• 1. Utility is Relative. The law of Diminishing Marginal Utility
is based on the assumption of independence of utilities. The
utility which a consumer derives from a commodity
depends on the quantity of that commodity only. In this
world, where quantity of one commodity depends not only
on its own quantity and price but also on the quantities and
prices of other commodities. In this view utility is relative
and not independent.
• 2. Utility is Immeasurable. One of the pivotal assumptions
of the law of Diminishing Marginal Utility is that utility is
measurable. In other words, it is assumed that a person can
say that he gets utility equal to 15 units from the
consumption of the first unit of a commodity and 10 units
from the second unit of it, and so on. But it has been
contended by modern economists that utility is a subjective
concept and is incapable of being measured quantitatively.7
3. The law of Diminishing Marginal Utility is not universally
applicable: The law does not apply to all types of
commodities and persons. A drunkard gets more
satisfaction on taking ‘successive’ cups of wine. Greed
increase with more money ( with some people).
In short, the law of Diminishing Marginal Utility is that all
its attention is focused on a single commodity. Actually a
consumer is thinking of many other things that he could
buy.
Equimarginal principle: states that consumer will get
maximum satisfaction when the marginal utility of money
expectation of a good is same as the marginal utility of
money expectation of any other goods.(consumer will
consider both marginal utility and price of goods,
MUx/Px=Muy/Py)
Market demand: By adding all individual’s demand, we get
market demand.
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• 5.4 Consumer surplus
• Consumer surplus is the amount a buyer is willing to
pay for a good minus the amount the buyer pays for
it.
• Consumer surplus measures the benefit which
buyers receive from participating in a market.
• Figure 5.1 shows consumer surplus. Horizontal line
represents the quantity of chocolate and vertical line
represents the price of chocolate. Here a buyer is
willing to pay $P2 for chocolate but the buyer pays
$P1 for it in the market. In figure the consumer
surplus is ABC area above the market price.
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Figure 5.1 Consumer Surplus
Price of
chocolate
p2 A
Consumer
Surplus Consumer Surplus = ABC
p1
B C
0 Q1 Quantity of chocolate
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• 5.6 Consumer equilibrium (using budget line
and indifference curve)
• To understand consumer equilibrium we have to
know budget line and indifference curve.
• Budget line
• Budget line shows the various combinations of
the two goods that the consumer can buy with a
given income and given price of the good .
• Figure 5.2 shows the budget line. Where the
consumer can buy with his income 6 units
clothing and 0 unit food at point M or 2 units
clothing and 3 unit food at point T or 0 units
clothing and 4 unit food at point N.
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Figure 5.2 Budget line
6 M
5
4
S
Clothing
2 T
1
N
0 1 2 3 4 5 6
Food
Table 5.2 Table of budget line
Combinations Quantity of Quantity of
Clothing Food
M 6 0
S 4 1
T 2 3
N 0 4
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Table 5.3 Table of Indifference curve
Combinations Quantity of Quantity of
Clothing Food
A 6 1
B 3 2
C 1.5 3
D 1 4
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Indifference curve: Indifference curve shows the various
combinations of the two goods that give the same level
of satisfaction (utility).
Properties of Indifference Curve
[Link] Indifference curve is preferred to lower IC .
[Link] is downward sloping
[Link] curves do not cross.
4. IC is bower inward.
Figure 3 shows the indifference curve. Where the
consumer likes combination (situation) A exactly as much
as B or C. The clothing –food combinations give same
utility (satisfaction) from 6 units clothing and 1 unit food
at point A or 3 units clothing and 2 unit food at point B or
1.5 units clothing and 4 unit food at point C.
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Figure: 3 Indifference curve
6 A
5
4
Clothing
3 B
2
C
U1
1
0 1 2 3 4 5 6
Food
• Indifference map : It refers to a set of
indifference curves corresponding to
different income levels of the consumer. In
an indifference map, indifference curves are
parallel and a higher indifference curve
represents a higher level of satisfaction.
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Figure: 4 Indifference map :
6
4
Clothing
2
U3
1 U2
U1
0 1 2 3 4 5 6
Food
• How will we achieve consumer equilibrium
• In graphically consumer equilibrium is achieved at
the point where the budget line is tangent to the
highest indifference curve. That means the
consumer equilibrium is achieved when the slope
of budget line is equal to the slope of indifference
curve.
• Figure 5 shows the consumer equilibrium.
Horizontal line/axis represents the quantity of food
and vertical line/axis represents the quantity of
clothing. MN is a budget line. U1, U2 and U3 is
indifference curves. The consumer reaches the
highest indifference curve attainable with given
income at the point B, which is the tangency of the
budget line with the highest indifference curve.
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Figure 5.4 Consumer’s equilibrium
6
M
5
4
Clothing
3 B
2
U3
1 U2
N U1
0 1 2 3 4 5 6
Food