Consumer
behavior
Theory
Module 4
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Learning Objectives
This chapter introduces you to:
• The Model of consumer behavior:
o Preference: What the consumer wants?
o Utility: what The benefit the consumer gets?
o Budget Constraints: What the consumer can afford?
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Consumer Behavior Model
The Model of consumer behavior is based on:
Preferences:
Individual tastes or preferences determine the amount of
pleasure people derive from the goods and services they
consume .
Utility :
Economists summarize a consumer's preferences using a
utility function, which assigns a numerical value to each
possible set of goods, reflecting the consumer's relative
ranking of these bundles .
Budget constraint :
Consumers face constraints or limits on their choices
(Prices, income, and government restrictions)
limit a consumer's ability to make purchases by determining
the rate at which a consumer can trade one good for
another
Consumers maximize their pleasure from consumption,
subject to the constraints they face
Preference: What the
consumer wants
• Indifference curve:
is a line showing all the
combinations of two goods
which give a consumer
equal utility. In other words,
the consumer would be
indifferent to these different
combinations.
If the two bundles suit his
tastes equally well, we say
that the consumer is
indifferent between the two
bundles.
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• The consumer is equally
happy at all points on any
given indifference curve,
but he prefers some
indifference curves to
others.
• Because he prefers more
consumption to less, higher
indifference curves are
preferred to lower ones.
• The slope at any point on
an indifference curve
equals the rate at which the
consumer is willing to
substitute one good for the
other. This rate is called the
marginal rate of substitution
(MRS).
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o MRS: the rate at which a consumer is willing to trade
one good for another.
• Four Properties of Indifference Curves
o Property 1: Higher indifference curves are preferred to
lower ones.
o Property 2: Indifference curves are downward sloping.
o Property 3: Indifference curves do not cross.
o Property 4: Indifference curves are bowed inward.
• The bowed shape of the indifference curve reflects
the consumer’s greater willingness to give up a good
that he already has in large quantity
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Utility
A consumer’s preferences determine the benefits or
satisfaction a person receives consuming a good or
service.
The benefit or satisfaction from consuming a good or
service is called utility.
Total Utility
Total utility is the total benefit a person gets from the
consumption of goods.
Marginal Utility
is the change in total utility that results from a one-unit
increase in the quantity of a good consumed.
◦ As the quantity consumed of a good increases, the
marginal utility from consuming it decreases.
◦ We call this decrease in marginal utility as the quantity
of the good consumed increases the principle of
diminishing marginal utility.
Marginal utility
&Total utility
units Total utility Marginal
utility
1 75 75
2 123 48
3 159 36
4 183 24
5 205 22
6 225 20
Total utility increases with the consumption
of a good.
Diminishing marginal utility.
Calculate Marginal Utility
# of Slices of Pizza Total Utility Marginal
(in dollars) Utility/Benefit
0 0
1 8
2 14
3 19
4 23
5 25
6 26
7 26
8 24
How many pizzas would you buy if the price per slice was $2? 12
Calculate Marginal Utility
# of Slices of Total Utility Marginal Marginal Cost
Pizza (in dollars) Utility/Benefit
0 0 0 $2
1 8 8 $2
2 14 6 $2
3 19 5 $2
4 23 4 $2
5 25 2 $2
6 26 1 $2
7 26 0 $2
8 24 -2 $2
How many pizzas would you buy if the price per slice was $2? 13
Calculate Marginal Utility
# of Slices of Total Utility Marginal Marginal Cost
Pizza (in dollars) Utility/Benefit
0 0 0 2
1 You will continue to
8 8 2
2 14 6 2
3
consume
19
until
5 2
4 Marginal
23 Benefit
4 = 2
5 25 2 2
6
Marginal
26
Cost
1 2
7 26 0 2
8 24 -2 2
How many pizzas would you buy if the price
per slice was $2? 14
$10 $5
Utility Maximization
# Times Marginal MU/P Marginal MU/P
Utility Utility
Going (Price =$10) (Price =$5)
(Movies) (Go Carts)
1st 30 10
2nd 20 5
3rd 10 2
4th 5 1
If you only have $25, what combination of
movies and go carts maximizes your utility?
Utility Maximization
# Times Marginal MU/P Marginal MU/P
Utility Utility
Going (Price =$10) (Price =$5)
(Movies) (Go Carts)
1st 30 $3 10 $2
2nd 20 $2 5 $1
3rd 10 $1 2 $.40
4th 5 $.50 1 $.20
If you only have $25, what combination of
movies and go carts maximizes your utility?
Utility Maximization
# Times Marginal MU/P Marginal MU/P
Utility Utility
Going (Price =$10) (Price =$5)
(Movies) (Go Carts)
1st 30 $3 10 $2
2nd 20 $2 5 $1
3rd 10 $1 2 $.40
4th 5 $.50 1 $.20
If you only have $25, what combination of
movies and go carts maximizes your utility?
Utility Maximization
# Times Marginal MU/P Marginal MU/P
Utility Utility
Going (Price =$10) (Price =$5)
(Movies) (Go Carts)
1st 30 $3 10 $2
2nd 20 $2 5 $1
3rd 10 $1 2 $.40
4th 5 $.50 1 $.20
If you only have $25, what combination of
movies and go carts maximizes your utility?
Utility Maximizing Rule
The consumer’s money should be spent so that
the marginal utility per dollar of each goods
equal each other.
MUx = MUy
Px Py
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Budget constraint
• Budget constraint: A household’s consumption possibilities are
constrained by its budget and the prices of the goods and
services it buys.
• the limit on the consumption bundles that a consumer can
afford
• People consume less than they desire because their spending
is constrained, or limited, by their income.)
The budget line describes the limits to the household’s
consumption choices.
The Budget Equation:
•We can describe the budget line by using a budget equation
The budget equation states that :
Expenditure = Income
•Call the price of product 1P1, the quantity Q1, the price of a
product 2 P2, the quantity Q2, and income Y.
•The budget equation is:
P1Q1 + P2Q2 = Y.
Budget line The
All the points on the line from A
household
to F are possible. This line,
called budget constraint, cannot afford
shows the consumption the points
bundles that the consumer can beyond the
afford. budget line.
It also shows the tradeoff
between two goods that the
consumer faces.
The slope of the budget
constraint measures the rate at
which the consumer can trade
one good for the other.
The slope of the budget
constraint equals the relative The household can
price of the two goods-the afford all the
price of one good compared points on or below
with the price of the other. the budget line.
o A household’s real income is the income expressed as
a quantity of goods the household can afford to buy.
o The real income in terms of soda is the point on the
budget line where it meets the y-axis.
o A relative price is the slope of the budget line which is
the price of one good divided by the price of another
good.
o The relative price shows how many sodas must be left
to see an additional movie.
The slope of the budget
line doesn’t change
A fall in the price of the
good on the x-axis
increases the affordable
quantity of that good
and decreases the
slope of the budget line.
The Figure shows the
rotation of a budget line
after a change in the
relative price of movies.
◦ An change in the
household’s income
brings a parallel shift of
the budget line.
◦ The slope of the
budget line doesn’t
change because the
relative price doesn’t
change.
◦ The Figure shows the
effect of a fall in
income.
Optimization: What the
consumer chooses
The consumer’s optimal choices: The consumer chooses the
point on his budget constraint that lies on the highest
indifference curve.
• We say that the indifference curve is tangent to the
budget constraint.
• At this point, called the optimum, the marginal rate of
substitution equals the relative price of the two goods.
• Thus, the consumer chooses consumption of the two
goods so that the marginal rate of substitution equals the
relative price.
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• Given a budget line of B1, the consumer will maximise
utility where the highest indifference curve is tangential
to the budget line (20 apples, 10 bananas)
• Given current income – IC2 is unobtainable.
• IC3 is attainable but gives less utility than the higher IC1
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References
• [Link], R. Kneebone, K. McKenzie and N. Rowe,
Principles of Microeconomics, Second Canadian
Edition (Thomson/Nelson). Univesity of Victoria,
Department of Economics: [Link]
• [Link]
• [Link]
• [Link]
• [Link]
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