Faculty of

Economic and
Management Sciences

CHAPTER 7
THEORY OF CONSUMPTION
(UTILITY)

Text Book
pp. 131 - 139
 Learning Outcomes
• Define utility and its importance in economics.

• Distinguish between cardinal and ordinal utility.

• Total utility and marginal utility and illustrate.

• Diminishing Marginal Utility and illustrate.

• Conditions for consumer equilibrium.

• Derivation of an Individual Demand curve

• Use marginal utility theory to predict the effects of

changing prices and incomes.
Utility
• Consumption is not an end in itself.

• The purpose of consumption behaviour is to maximise

satisfaction.

• Utility is the degree of satisfaction that a consumer

derives or expects to derive from the consumption of a
good or service.

– It measures how much one enjoys watching a movie or

driving a particular car, or enjoyment of eating chocolates
or the benefit of attending a particular lecture.

• It is a tool used to allocate scarce resources.

 Utility
• It is an abstract and subjective concept rather than a
concrete, observable and objective one.

• The units to which we assign an “amount” of utility,

therefore, are arbitrary units; representing a relative
value.

• There is no yardstick with which utility can be measured

objectively.
 CARDINAL & ORDINAL UTILITY
The idea that utility (the satisfaction
that a consumer derives from
Cardinal
consuming a product) can be
Utility measured in some way.

Ranking of different combinations

Ordinal
of consumer goods and services in
Utility order of preference

The utility approach is based on the notion of cardinal utility

The Cardinal & Ordinal Concept
Cardinal Ordinal
Christoffel Wiese $ 7.0 billion 1. Christoffel Wise

Nicky Oppenheimer $6.6 billion 2. Nicky Oppenheimer

Johann Rupert $6.1 billion 3. Johann Rupert

Koos Bekker $1.8 billion 4. Koos Bekker

Patrice Motsepe $1.1 billion 5. Patrice Motsepe

Source: Forbes (2015) [Link]

7
Cardinal & Ordinal Utility
Cardinal utility
Involves the
idea that Ordinal utility
utility can be Therefore
measured in Cannot Cardinal utility
numbers. measure utility. (Utility Approach)
is quantitative
We assume
that people Involves the
can measure ranking of Ordinal utility
satisfaction different (Indifference
with units bundles of Approach) is
called utils goods in order qualitative
(units of of preference.
utility).
Ordinal Utility

• Ordinal utility involves ranking or ordering of

different bundles of consumer goods and services
according to preferences.

• The size of utility differences cannot be established.

• The word “ordinal” is derived from ordering.

COMPARISION CHART
BASIS FOR COMPARISON CARDINAL UTILTY ORDINAL UTILITY
Meaning Involves the idea that utility Cannot measure utility.
can be measured in numbers
Involves the ranking of
different bundles of goods
in order of preference.

Approach Quantitative Qualitative

Realistic Less More
Measurement Utils Ranks
Analysis Marginal Utility Analysis Indifference curve Analysis
Promoted by Classical and Neo –Classical Modern Economists
Economists
Cardinal Utility Approach:
Total and marginal utility
• Marginal utility
– The extra satisfaction which a consumer derives from the
consuming an additional unit of a good.

• Total utility
– The total satisfaction which a consumer derives from the
consumption of a particular good over a period of time.
Marginal utility
• The extra or additional utility that a consumer derives
from the consumption of one additional unit of a good is
called marginal utility (MU).
∆TU
MU =
∆Q

• If homogeneous or identical units of a good are

consumed one after the other, the marginal utility will
decline until it reaches zero.
Law of Diminishing Marginal Utility
• The law of diminishing marginal utility states that the
marginal utility of a good or service eventually declines
as more of it is consumed during any given period. OR

• As the consumer consume more units of a particular

good, the consumers total utility in respect of that good
will increase at a decreasing rate.

• In other words the addition to total utility from

consuming each additional unit of the good will
decrease.
Law of Diminishing Marginal Utility
Example 1
Law of Diminishing Marginal Utility
Example 2
If you are really hungry the first
burger is delicious. And makes you
really satisfied.

You decide to buy another burger,

this burger also adds to your
satisfaction but not by so much as the
first burger.

You buy a third burger, but this was too

much and you reach disutility. You feel
sick, your satisfaction is decreasing.
Law of Diminishing Marginal Utility
Example 3

Imagine a man in the middle

of a dessert who is very
thirsty.

Check the next slide!

Law of Diminishing Marginal Utility
Imagine a man in the middle of
a dessert who is very thirsty.

Units Total Utility Marginal Utility

1st bottle 20 20

2nd bottle 32 12

3rd bottle 40 8

4th bottle 42 2

5th bottle 42 0

6th bottle 39 –3
Law of Diminishing Marginal Utility

24

20 20
16

12 12
8 8
4
2
0 0
1 2 3 4 5 6
-4 -3

-8
Law of Diminishing Marginal Utility
48
44
42 42
40 40 39
36
32 32
28
24
20
20 20
16
12
12
8
8
4 2
0
0 -3
-4 1 2 3 4 5 6
-8
Law of Diminishing Marginal Utility
• The first glass of water to a thirsty man gives 20 units of utility.

• When he takes second glass of water, the marginal utility goes

down to 12 units.

• When he consumes fifth glass of water, the marginal utility

drops down to zero and if the consumption of water is forced
further from this point, the utility changes into disutility (–3).

• Here it may be noted that the utility of the successive units

consumed diminishes not because they are of inferior in quality
than that of others. We assume that all the units of a commodity
consumed are exactly alike.
Law of Diminishing Marginal Utility
• Even though marginal utility declines, total utility still
increases as long as marginal utility is positive.

• Total utility will decline only if marginal utility is

negative.
Total Utility
• It is the sum of all the marginal utilities.

• Total utility increases as long as marginal utility is positive.

• Total utility reaches a maximum when the marginal utility

is zero (the consumer is satiated).

• Total utility decreases when the marginal utility becomes

negative (when disutility sets in)

• Average utility= Total utility of product/total units of the

product
 Total utility
# of slices of bread Total Utility Additional utility

0 - -
1 70 70
2 110 40
3 130 20
4 140 10
5 145 5
6 145 0
7 140 -5
Total Utility & Marginal Utility: Example

Marginal utility

1st 2nd 3rd 4th 5th 6th 7th

70 utils 40 utils 20 utils 10 utils 5 utils 0 utils - 5 utils

Total utility

70 utils 110 utils 130 utils 140 utils 145 utils

Marginal Utility
change in total utility
M arg inal utility =
change in quantity

# of slices of bread Marginal utility Total utility

0 - -
1 70 70
2 40 110
3 20 130
4 10 140
5 5 145
6 0 145
7 -5 140
Total Utility
140 (5,145) (6,145)
(4,140) (7,140)
(3,130)
120 Slices MU TU
TU (2,110) 0 0
100
1 70 70
80 Total 2 40 110
Utility 3 20 130
(1,70)
60 4 10 140
5 5 145
40
6 0 0
20 7 -5 140

(0,0) 1 2 3 4 5 6 7 8
Number of Slices of Bread
Marginal Utility
140

120 Slices TU MU
MU 0 0
100
1 70 70
80 Marginal 2 110 40
(1,70)
Utility 3 130 20
60 4 140 10
(2,40) 5 145 5
40
6 145 0
(3,20)
20 7 140 -5
(4,10)
(5,5)
(6,0)
(7,-5)
1 2 3 4 5 6 7 8
Number of Slices of Bread
 Total Utility & Marginal Utility
140

120
Total
Utility 100 Total Utility is
at Maximum
80 when…
Marginal
Utility 60
Slices TU MU
0 0 40
1 70 70 Marginal
2 110 40
3 130 20
20 Utility = 0
4 140 10
5 145 5
6 145 0
-1 0 1 2 3 4 5 6 7 8
7 140 -5
Number of Slices of Bread
 Application of Marginal Utility
• The utility maximising consumer, subject to no
constraints, would consume 5 slices of bread where
total utility is greatest.

Slices TU MU
0 0
1 70 70
2 110 40
3 130 20
4 140 10
5 145 5
6 145 0
7 140 -5
 BRIEF ASSESSMENT
Utility from consuming a good is understood
1 by economists to mean ________
A how often we consume the good.
how much satisfaction or benefit we get from consuming
B
the good.
C how we best use the good.
D how much it costs to buy the good.

________ is the additional satisfaction a

2 person receives from consuming an extra unit
of a good.
A Total utility
B Marginal utility
C Diminishing marginal utility
D Preferences
 BRIEF ASSESSMENT

3 Which one of the following correctly explains

the way in which economists view utility?
A ordinal utility can be measured.
utility is a measure of satisfaction gained from
B
producing a good.
when consuming the same good, utility is constant
C
across individuals.
When consuming the same good, utility varies
D
across individuals.
 BRIEF ASSESSMENT
At what quantity consumed will diminishing
4 marginal utility begin?
Quantity Consumed Total Utility
1 10
2 21
3 45
4 65
5 70

A first
B fourth
C second
D fifth
 BRIEF ASSESSMENT
5 As more of a good is consumed, total utility
____ , marginal utility ____.
A increases; is unaffected
B increases; increases
C decreases; decreases
D increases; decreases

As Sally increases her consumption of a good,

6 she experiences diminishing marginal utility if
her total utility
A increases at a constant rate.
B increases at a decreasing rate.
C increases at an increasing rate.
D diminishes.
 BRIEF ASSESSMENT
Diminishing marginal utility will set in with the
7 consumption of ________ traditional beer.
Traditional beer consumed Total utility
0 0
1 90
2 190
3 270
4 350
5 420
6 420
7 400
A first
B second
C third
D fourth
 BRIEF ASSESSMENT
Marginal utility becomes negative with the
8 consumption of the ________
Traditional beer consumed Total utility
0 0
1 90
2 190
3 270
4 350
5 420
6 420
7 400
A fourth
B fifth
C sixth
D seventh
 BRIEF ASSESSMENT
Based on the table below, you can conclude
9 that the ________
Traditional beer consumed Total utility
0 0
1 90
2 190
3 270
4 350
5 420
6 420
7 400

A Marginal utility of the 2nd traditional beer is 270 utils

B Marginal utility of the 4th traditional beer is 60 utils
C Average utility of 3 traditional beers is 90 utils
D Average utility of 5 traditional beers is 80 utils
 BRIEF ASSESSMENT

10 Total utility is maximized when

the marginal utility per rand spent is equal for all
A
goods
B the marginal utilities are all zero.

C the marginal utilities are all maximized.

D the marginal utilities are all negative.

Derivation of the Demand Curve
• A rational consumer, before, purchasing a commodity
compares the price of the commodity which he has to pay
for with the utility of a commodity he receives from it.

• As the consumer purchases more and more units of a

commodity, marginal utility diminishes.

• So long as the marginal utility of a commodity is higher

than its price (MUX > PX), the consumer would demand
more and more units of it till its marginal utility is equal to
its price MUX = PX.
Derivation of the Demand Curve
(Cont…)

• To put it differently, as the consumer consumes more

and more units of a commodity, its marginal utility
goes on diminishing.
• So it is only at a diminishing (lesser) price that the
consumer is willing to demand more and more units of
a commodity.
• When MUX = PX the consumer is said to be in
equilibrium.
 Derivation of the Demand Curve
(Cont…)

Marginal Utility Graph Demand Curve

MU
figure 1. figure 2.
PX

MU1 P1

MU2 P2

MU3 P3

0 0
X1 X2 X3 X X1 X2 X3 X
Quantity Quantity
Consumer Equilibrium :
(One product)
• The consumer is faced with a choice among many
commodities that he can and would like to pay.

• He therefore, consciously or unconsciously compares the

satisfaction which he obtains from the purchase of the
commodity and the price which he pays for it.

• If he thinks the utility of the commodity is greater than the

utility of money, he buys that commodity.
Consumer Equilibrium (Cont…)

• As he buys more and more of that commodity, the

utility of the successive units begins to diminish.

• He stops further purchase of the commodity at a point

where the marginal utility of the commodity and its
price are just equal.

• If he pushes the purchase further from his point of

equilibrium, then the marginal utility of the commodity
will be less than that of price and the household will be
a loser.
Consumer Equilibrium (Cont…)
• A consumer will be in equilibrium with a single
commodity symbolically when:

MU X = PX
• Marginal utility is the extra satisfaction you derive
when you consume an additional unit of a product.
• Therefore, marginal utility determines what the
consumer is willing to pay for a good.
 Weighted Marginal Utility
MU X MU Y
= 10 = 20
PX PY
• The weighted marginal utility is given by dividing the
marginal utility for that unit by the price per unit.

• The marginal utility per rand spent on Y is greater than the

marginal utility per rand spent on X.

• Hence product Y gives more value for money that product

X.
Consumer equilibrium:
(Two products)

• Consumer’s equilibrium with two or more goods

purchased.

• A rational consumer in order to get the maximum

satisfaction from his limited means compares not only
the utility of a particular commodity and the price but
also the utility of the other commodities which he can
buy with his scarce resources.
 Consumer equilibrium:
(Two products)
• If he finds that a particular expenditure in one use is
yielding less utility than that of other, he will try to
transfer a unit of expenditure from the commodity
yielding less marginal utility to commodity yielding
higher marginal utility.

• The consumer will reach his equilibrium position

when it will not be possible for him to increase the
total utility by transferring expenditure from less
beneficial uses to more beneficial uses.
Consumer Equilibrium Conditions
(Two products or more)
1. All his income must be spent

2. The consumer will maximize total utility from his given income
when the utility from the last rand spent on each good is the
same and all income has been spent. Algebraically, this is

MU A MU B MU C
= = = ...
PA PB PC
Consumer equilibrium:
(Two products) Example 1
• This is known as the equi-marginal principle or the
law of maximum satisfaction.

• Suppose a person has R5.00 with him which he wishes

to spend on two commodities, tea and chocolate.

• Tea and chocolate are costing R1.00 each.

Consumer equilibrium:
(Two products) Example 1
Quantity of Marginal Utility Marginal Utility
Tea/Chocolate of Tea of Chocolate
1st 10 12
2nd 8 10
3rd 6 8
4th 4 6
5th 2 3

Total Utility = 30 Total Utility = 39

Equi-marginal principle:
example
• A rational consumer would like to get maximum
satisfaction from R5.00.

• Tea and chocolate are costing R1 each.

• He can spend this money in three ways.

1. R5.00 may be spent on tea only.

2. R5.00 may be spent on chocolates only.

3. R5.00 may be spent on both tea and chocolates.

Equi-marginal principle:
example 1

What is the total utility if he spends all his income on?

1. Tea only = ?

2. Chocolate only = ?

3. R4 tea and R1 chocolate = ?

4. R3 tea and R2 chocolate = ?

5. R2 tea and R3 chocolate = ?

6. R1 tea and R4 chocolate = ?

Equi-marginal principle:
example 1

• By spending R4.00 on tea and R1.00 on chocolates,

– he gets 40 utils (10+8+6+4+12=40).

• By spending R3.00 on tea and R2.00 on chocolates,

– he derives 46 Utils (10+8+6+12+10=46).

• By spending R2.00 on tea and R3.00 on chocolates,

– he gets 48 utils (10+8+12+10+8=48).

• By spending R1.00 on tea and R4.00 on chocolates,

– he gets 46 utils (10+12+10+8+6=46).

Equi-marginal principle:
example 1
• By spending R2.00 on tea and R3.00 on chocolates,
the consumer maximizes his total utility to 48 utils.
• When he spends R2.00 on tea and R3.00 on
cigarettes, the marginal utility derived from both
these commodities is equal to 8.
• When the marginal utilities of the two commodities
are equalized, the total utility is then maximum (48
utils).
Equi-marginal Principle:Example 2

Income:R9.00
Price of X is R2.00 Price of Y is R1.00
Units of X MUx Units of Y MUy

1 10 1 8
2 8 2 7
3 6 3 6
4 4 4 5
5 3 5 4
6 2 6 3
Equi-marginal Principle:Example 2

Income:R9.00
Price of X is R2.00 Price of Y is R1.00
Units of X MUX / PX Units of Y MUY/PY

1 5 1 8
2 4 2 7
3 3 3 6
4 2 4 5
5 1.5 5 4
6 1 6 3
Equi-marginal Principle: Example 2

a) What quantities of each will you purchase to

maximise utility?
b) What total utility will you realise?
c) Assume that other things remain unchanged but
that the price of X falls to R1.00. What quantities
of X and Y will you now purchase?
d) What total utility will you now realise?
 Principle of Equi-marginal utility
(Cont…)

MU TEA MU CHOC
=
PTEA PCHOC
• The Marginal utility derived from the last rand`s worth of
tea (MUTEA) is equal to the Marginal utility derived from
the consumption of the last extra rand`s worth of
chocolate (MUCHOC).

• The consumer is in a state of equilibrium.

• There is no incentive to alter this balance.

 Principle of Equi-marginal utility
(Cont…)
MU TEA MU CHOC
>
PTEA PCHOC
Suppose that the marginal utility per rand spent on tea is
greater than the marginal utility per rand spent on
chocolate. How can equilibrium be restored?

• In order to restore equilibrium, the consumer will buy more

of tea, thus reducing marginal utility of tea and less of
chocolate thereby increasing its marginal utility.

• The consumer will continue substituting tea for chocolate

until equilibrium is achieved.
 Summary
• To maximise satisfaction, the consumer should allocate
his or her money income so that the last rand spent on
each product yields the same amount of marginal utility.

• This is the utility-maximising rule.

• There is no incentive to alter the expenditure pattern

provided there is no change in taste, income, products, or
prices.

• The consumer is thus in a state of equilibrium.

NEXT LECTURE – THEORY OF PRODUCTION

 Faculty of
Economic and
Management Sciences
CONSUMER
EQUILIBRIUM
PRACTICE QUESTIONS

Text Book
pp. 121 - 130
Question 1: Complete the Table
Marginal Utility
Slices of Pizzas Total Utility (TU)
(MU)
1 10 ? (i)
2 18 ? (ii)
3 ? (iii) 6
4 ? (iv) 4
5 30 ? (v)
6 ? (vi) 0
7 ? (vii) -2
8 23 ? (viii)
Question 1: Answers for the Table
Marginal Utility
Slices of Pizzas Total Utility (TU)
(MU)
1 10 10
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2
8 23 -5
Example

John Scott has R200 per week available to spend on

beer and cigarettes. Beer costs R10 per bottle and
cigarettes cost R40 per packet. Suppose John buys 8
bottles of beer and 3 packets of cigarettes and that his
marginal utility from beer is then 20 utils and that from
cigarettes 35 utils. Is he in equilibrium? If not, should
he buy more beer or more cigarettes? Explain.
ANSWER:
• Weighted marginal utility of beer = MUB/PB = 20/10 = 2.
• Weighted marginal utility of cigarettes = MUC/PC = 35/40
= 0,875.
• He is not in equilibrium because the weighted marginal
utilities are not equal. He gets more “value for money”
from beer and therefore he should buy more beer and
fewer cigarettes.
Question 2

Consider the table in the next slide and answer the

following question:

Assume that Lebo’s income is R12,00 and there are

only two products in the economy, apples and bread.
Suppose that the price of an apple is R2 (Pa = 2) and
the price of bread R1 (Pb = 1). The following table
shows Lebo’s marginal utilities of the two products:

Determine the combinations of apples and bread which

Lebo can afford.
Question 2
Income: R12.00
Qty of Qty of
MUa Pa MUb Pb
Apples Bread
1 16 R2 1 11 R1
2 14 R2 2 10 R1
3 12 R2 3 9 R1
4 10 R2 4 8 R1
5 8 R2 5 7 R1
6 6 R2 6 6 R1
7 4 R2 7 5 R1
8 2 R2 8 4 R1
Question 2 (Cont…)
Income: R12.00
Qty of Qty of
Mua / Pa Mub / Pb
Apples Bread
1 8 1 11
2 7 2 10
3 6 3 9
4 5 4 8
5 4 5 7
6 3 6 6
7 2 7 5
8 1 8 4
 Question 3
Assume that the price of apples rises to R4, while the price of bread remains the same.
What is the new combination. Calculate the corresponding total utility. Prove that
MUA/PA = MUB/ PB

Qty of Qty of
MUa Pa MUb Pb
Apples Bread
1 16 R4 1 11 R1
2 14 R4 2 10 R1
3 12 R4 3 9 R1
4 10 R4 4 8 R1
5 8 R4 5 7 R1
6 6 R4 6 6 R1
7 4 R4 7 5 R1
8 2 R4 8 4 R1
Question 3 (Cont…)
Income: R12.00
Qty of Qty of
Mua / Pa Mub / Pb
Apples Bread
1 4 1 11
2 3.5 2 10
3 3 3 9
4 2.5 4 8
5 2 5 7
6 1.5 6 6
7 1 7 5
8 0.5 8 4
Additional link videos of utility

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