Chapter 3

Consumer Behavior
 Introduction
• Consumer behavior explains the principles underlying
consumer demand.
• We see how consumers make consumption decisions.
• How do their preferences and budget constraints
determine their demands for various goods?
• And why different goods have different demand
characteristics.

2
 Topics to be Discussed
• Consumer Preferences

• Budget Constraints

• Consumer Choice

• Marginal Utility and Consumer Choices

3
 Consumer Behavior
• There are three steps involved in the study of consumer
behavior.
1) We will study consumer preferences.
• To describe how and why people prefer one good
to another.
• We will see how a consumer’s preferences for
various goods can be described graphically and
algebraically.

4
 Budget Constraints
2) Then we will turn to budget constraints.
• Consumers consider prices.
• Therefore, we take into account the fact that
consumers have limited incomes which restrict the
quantities of goods they can buy.
• What does a consumer do in this situation?
• We find the answer to this question by putting
consumer preferences and budget constraints
together in the third step.

5
 Consumer choice
3) Finally, we will combine consumer preferences
and budget constraints to determine consumer choices.
• What combination of goods will consumers buy to
maximize their satisfaction?
• These combinations will depend on the prices of
various goods.
• Thus, understanding consumer choice will help us
understand demand.
• These three steps are the basics of consumer
theory.

6
 Consumer Behavior
• Are consumers as rational and informed as
economists often make them out to be?

7
 Consumer Behavior
• We know that consumers do not always make
purchasing decisions rationally.

• Sometimes, for example, they buy on impulse, ignoring

or not fully accounting for their budget constraints (and
going into debt as a result).

• Sometimes consumers are unsure about their

preferences or are swayed by the consumption decisions
of friends and neighbors, or even by changes in mood.

8
 Consumer Preferences
Market Baskets/ Bundle
• A market basket is a collection of one or more commodities.
• A market basket might contain the various food items in a grocery cart –
like quantities of food, clothing, housing, and many more.

• How do consumers select market baskets?

• How do they decide, for example, how much food versus clothing to buy
each month?

• Although selections may occasionally be arbitrary, consumers usually

select market baskets that make them as well off as possible.

9
 Consumer Preferences
Three basic assumptions of preferences form the basis of consumer theory and
we believe that these assumptions hold for most people in most situations.
1. Preferences are complete and rankable. Consumers can compare and
rank all possible baskets. An individual is able to state which of any two
options is preferred.
For any two market baskets A and B, a consumer will prefer A to B, will prefer B to A, or will
be indifferent between them. By indifferent we mean that a person will be equally satisfied
with either basket.

2. Preferences are transitive.

A > B, and B > C, then A > C.

3. Consumers always prefer more of any good to less.

In addition, consumers are never satisfied or satiated; more is always better, even if just a little better.

These three assumptions form the basis of consumer theory. They do not
explain consumer preferences, but they do impose a degree of rationality
and reasonableness on them.

10
 Consumer Preferences
• Of course, some goods, such as air pollution, may be undesirable, and
consumers will always prefer less.
• BADS - Things for which less is preferred to more. Examples: Air and noise
pollution.
• We ignore these “bads” in the context of our immediate discussion of
consumer choice because most consumers would not choose to purchase
them.
• How do we account for bads in the analysis of consumer preferences?
• The answer is simple: We redefine the product under study so that
consumer tastes are represented as a preference for less of the bad. This
reversal turns the bad into the good.
• Thus, for example, instead of a preference for air pollution, we will discuss
the preference for clean air.

11
 Consumer Preferences
Indifference Curves

• We can show a consumer’s preferences

graphically with the use of indifference curves.

• ID-Curve represents all combinations of market

baskets that provide a consumer with the same level
of satisfaction.

• Assume that there are only two goods available

for consumption: food F and clothing C.
12
 Consumer Preferences
Market Basket Units of Food Units of Clothing

A 20 30
B 10 50
D 40 20
E 30 40
G 10 20
H 10 40

To explain the theory of consumer behavior, we will ask whether consumers prefer
13
one market basket to another.
 Consumer Preferences
The consumer prefers
A to all combinations
in the blue box, while
Clothing all those in the pink
(units per week) box are preferred to A.
50 B
In fact, we can easily
compare all market
baskets in the two
40 H E
shaded areas (such as
E and G) to A because
A they contain either
30 more or less of both
food and clothing.
D However, A cannot be
20 G
compared with B, D,
or H without additional
information about
10 consumer ranking.

Food
10 20 30 40 (units per week)
14
 Consumer Preferences
Combination B,A, & D yield the same
satisfaction
•E is preferred to U1
•U1 is preferred to H & G
•The indifference curve U1 that passes
through market basket A shows all
baskets that give the consumer the
same level of satisfaction as does
market basket A; these include baskets
B and D. Our consumer prefers basket
E, which lies above U1, to A, but prefers
A to H or G, which lie below U1.

This curve indicates that the consumer

is indifferent among these three market
baskets. It tells us that in moving from
market basket A to market basket B, the
consumer feels neither better nor worse
off in giving up 10 units of food to obtain
20 additional units of clothing.

ID-Curve represents all combinations of market baskets that provide a consumer with the same level 15
of
satisfaction.
 Consumer Preferences
• Indifference Curves- properties
– Indifference curves slope downward from left to the
right.
• If it sloped upward it would violate the assumption
that more of any commodity is preferred to less.

– Any market basket lying above and to the right of an

indifference curve is preferred to any market basket that
lies on the indifference curve.

– Finally, indifference curves cannot cross.

• This would violate the assumption that more is
preferred to less.
16
 Indifference Curves

• Note that the indifference curve in Figure slopes

downward from left to right.
• To understand why this must be the case, suppose
instead that it sloped upward from A to E.
• This would violate the assumption that more of any
commodity is preferred to less.
• Because market basket E has more of both food and
clothing than market basket A, it must be preferred to A
and therefore cannot be on the same indifference curve
as A.

17
 Consumer Preferences
• Indifference Maps
• A set of indifference curves is called an indifference
map.
• Each indifference curve in the map shows the market
baskets among which the person is indifferent.
• The figure shows three indifference curves that form part
of an indifference map (the entire map includes an
infinite number of such curves).

18
 Consumer Preferences
Market basket A
is preferred to B.
Market basket B is
Clothing
preferred to D.
(units per week)
U3 generates the
E highest level of
D A satisfaction,
followed by
indifference
B
curves U2 and
U3 U1.
U2

U1

Food
(units per week)
19
 Why ID-Curves can’t intersect?
• Indifference curves cannot intersect.
• To see why we will assume the contrary and see how the resulting graph
violates our assumptions about consumer behavior.
• The figure shows two indifference curves, U1 and U2, that intersect at A.
• Because A and B are both on indifference curve U1, the consumer must
be indifferent between these two market baskets.
• Because both A and D lie on the indifference curve U2, the consumer is
also indifferent between these market baskets.
• Consequently, using the assumption of transitivity, the consumer is also
indifferent between B and D. But this conclusion can’t be true: Market
basket B must be preferred to D because it contains more of both food
and clothing.
• Thus, intersecting indifference curves contradict our assumption that
more is preferred to less.

20
 Why ID-Curves can’t intersect?
Indifference Curves
Clothing
Cannot Cross
(units per week) U1
U2

The consumer should

be indifferent between
A, B and D. However,
A B contains more of
both goods than D.

B
D

Food
(units per week)
21
 Consumer Preferences
Marginal Rate of Substitution

• To quantify the amount of one good that a consumer will give up to obtain more of
another good, we use a measure called the marginal rate of substitution (MRS).
– It is measured by the slope of the indifference curve.
– The MRS of food F for clothing C is the maximum amount of clothing
that a person is willing to give up to obtain one additional unit of food.
– Suppose, for example, the MRS is 3. This means that the consumer
will give up 3 units of clothing to obtain 1 additional unit of food. If the
MRS is 1/2, the consumer is willing to give up only 1/2 unit of clothing.
– Thus, the MRS measures the value that the individual places on 1
extra unit of a good in terms of another.

22
 Consumer Preferences
• When we describe the MRS, we must be clear about
which good we are giving up and which we are getting
more of.

• To be consistent, we will define the MRS in terms of the

amount of the good on the vertical axis that the
consumer is willing to give up in order to obtain 1 extra
unit of the good on the horizontal axis.

23
 Consumer Preferences
We add the negative sign to
Clothing 16 A
make the marginal rate of
(units substitution a positive number.
per week) 14 MRS = 6 (Remember that delta C is
(GIVEN UP) always negative; the consumer
12 -6
gives up clothing to obtain
Starting at additional food.)
market basket 10 B
A and moving 1
to basket B, 8 -4
we see that D MRS = 2 MRS   C
the consumer 6 1 F
is willing to E
give up 6
-2
4 G
units of 1 -1
clothing to
2 1
obtain 1 extra
unit of food. Food
1 2 3 4 5 (units per week)
24
 Consumer Preferences
• Note that in the above figure, the MRS
falls as we move down the indifference
curve.
• This is not a CONINCIDENCE.
• This decline in the MRS reflects an
important characteristics of consumer
preferences.

25
 Consumer Preferences
Marginal Rate of Substitution

• We will now add a fourth assumption regarding

consumer preference:
– Along an indifference curve there is a diminishing
marginal rate of substitution.
• Note the MRS for AB was 6, while that for DE was 2.
• As food consumption increases, the slope of the
indifference curve falls.

• Question
– What are the first three assumptions?
26
 Consumer Preferences
Marginal Rate of Substitution

• As more of one good is consumed, a consumer would

prefer to give up fewer units of a second good to get
additional units of the first one.

• Consumers prefer a balanced market basket.

27
 Consumer Preferences
• Question: Is it reasonable to expect
indifference curves to be convex?

28
 Consumer Preferences
• Yes. As more and more of one good is consumed, we
can expect that a consumer will prefer to give up fewer
and fewer units of a second good to get additional units
of the first one.

• As we move down the indifference curve as shown in the

figure and the consumption of food increases, the
additional satisfaction that a consumer gets from still
more food will diminish. Thus, he will give up less and
less clothing to obtain additional food.

29
 Consumer Preferences
• The shape of an indifference curve describes
the willingness of a consumer to
substitute one good for another.

• An indifference curve with a different shape

implies a different willingness to substitute.

30
 Consumer Preferences
Marginal Rate of Substitution

•Perfect Substitutes and Perfect Complements

– Two goods are perfect substitutes when the marginal rate of
substitution of one good for the other is constant.
– Two goods are perfect complements when the indifference
curves for the goods are shaped as right angles.

31
 Consumer Preferences
Apple
Juice
(glasses) 4
Perfect The figure shows Bob’s
preferences for apple juice
Substitutes and orange juice. These
two goods are perfect
substitutes for Bob
3 because he is entirely
indifferent between having
a glass of one or the other.
In this case, the MRS of
2
apple juice for orange juice
is 1: Bob is always willing
to trade 1 glass of one for 1
1 glass of the other.

Orange Juice
0 1 2 3 4 (glasses)
32
Consumer Preferen Perfect
Figure illustrates
Jane’s preferences for
Complements
ces
left shoes and right
shoes. For Jane, the
two goods are perfect
Left complements because
Shoes a left shoe will not
4 increase her
satisfaction unless she
can obtain the
matching right shoe. In
3 this case, Jane will not
give up any left shoes
to get additional right
shoes. Two goods are
2 perfect complements
when the indifference
curves for both are
1 shaped as right
angles.
•Two goods for which
0 1 2 3 4 the MRS is zero or
Right infinite 33
Shoes
 Consumer Preferences
Designing New Automobiles (I)

• Automobile executives must regularly decide wh

en to introduce new models and how much mon
ey to invest in re-styling.

• An analysis of consumer preferences would help

to determine when and if car companies should
change the styling of their cars.

34
 Consumer Preferences
Styling

Performance
35
 Consumer Preferences
Styling

These consumers are

willing to give up
considerable
styling for additional
performance

Performance
36
 Consumer Preferences
Styling

Performance
37
 Consumer Preferences
Styling

These consumers are

willing to give up
considerable
performance for
additional styling

Performance
38
 Consumer Preferences
• We already describe consumer preferences graphically
building on the assumption that consumers can rank
alternatives.
• It is often useful to assign numerical values to individual
baskets.
• Using this numerical approach, we can describe
consumer preferences by assigning scores to the levels
of satisfaction associated with each indifference curve.

39
 Consumer Preferences
• Utility
– Utility: Numerical score representing the
satisfaction that a consumer gets from a given
market basket.
– If buying 3 copies of Microeconomics makes
you happier than buying one shirt, then we
say that the books give you more utility than
the shirt.

40
 Utility Function
• A Utility Function is a formula that assigns
a level of utility to each market basket.
• Suppose that Phil’s utility function for food
(F) and clothing (C) is u(F,C) = F + 2C.
• If F = 8 and C = 3, then u(F,C) =
8+2*3=14.
• What if F = 4 and C = 4?

41
 Consumer Preferences
Utility Functions & Indifference Curves
Clothing
(units
Assume: U = FC
per week)
Market Basket U = FC
•A utility
C 25 = 2.5(10)
function can 15
be represented A 25 = 5(5)
by a set of B 25 = 10(2.5)
indifference
curves, each
C
with a 10
numerical
indicator. This
figure shows
three A U3 = 100 (Preferred to U2)
indifference 5
curves (with B
utility levels of U2 = 50 (Preferred to U1)
25, 50, and
100,
U1 = 25
respectively) Food
associated 0 5 10 15 (units per week)
with the utility 42
function FC.
 Consumer Preferences
• It is important to stress that the utility function is simply a way of
ranking different market baskets.

• The fact that U3 has a level of utility of 100 and U2 has a level of 50
does not mean that market baskets on U3 generate twice as much
satisfaction as those on U2.

• This is so because we have no means of objectively measuring a

person’s satisfaction from the consumption of a market basket.

• Thus whether we use indifference curves or a measure of utility, we

know only that U3 is better than U2 and that U2 is better than U1. We
do not, however, know by how much one is preferred to the other.

43
 Consumer Preferences
• Ordinal Versus Cardinal Utility
– Ordinal Utility Function: places market baskets
in the order of most preferred to least preferred,
but it does not indicate how much one market
basket is preferred to another.
(A>B=C>D)
– Cardinal Utility Function: utility function
describing the extent to which one market
basket is preferred to another.
– by how much one market basket is preferred to another
(A>B=C>D; U(A)=8.5, U(B)=8, U(C)=8, U(D)=1)
44
 Consumer Preferences
• Ordinal Versus Cardinal Rankings
– The actual unit of measurement for utility is not
important. As our objective is to understand consumer
behavior, all that matters is knowing how consumers
rank different baskets.
– Therefore, we will work only with ordinal utility
functions.
– An ordinal ranking is sufficient to explain how most
individual decisions are made.

45
Can Money Buy Happiness?

46
 Can Money Buy Happiness?
• Research comparing various measures of happiness suggests that
the answer is a qualified yes.

• In one study, an ordinal scale for happiness was derived from the
answer to the following question. “How satisfied are you at present
with your life, all things considered?”5 Possible responses ran on a
scale from 0 (completely dissatisfied) to 10 (completely satisfied).

• Income was found to be a very strong predictor of happiness

(another strong predictor was whether a person was employed or
not). On average, as income increased by one percent, the
satisfaction score increased one half a point.

47
 Can Money Buy Happiness?
• Can one compare levels of happiness across as well as
within countries?

48
 Can Money Buy Happiness?
• Can one compare levels of happiness across as well as
within countries?
• Once again, the evidence says yes.
• In a separate survey of individuals in 67 countries, a
team of researchers asked: “All things considered, how
satisfied are you with your life as a whole these days?”
Responses were given on a ten-point scale, with 1
representing the most dissatisfied and 10 the most
satisfied.
• Income was measured by each country’s per-capita
gross domestic product in U.S dollars.

49
Income and happiness

50
 Income and happiness
• Comparisons across countries are difficult because there are likely
to be many other factors that explain satisfaction besides income
(e.g., health, climate, political environment, human rights, etc.).
• Interestingly, a recent survey of 136,000 individuals from 132
countries shows that the United States, which had the highest GDP
per capita, was ranked 16th overall in happiness.
• The number 1 rated country was Denmark (Finland was rated
number 1 in 2020 and 2019). Generally, countries in Northern
Europe and English-speaking countries did well overall, as did a
number of Latin American countries.
• However, South Korea and Russia were not rated as high as their
incomes would predict.

51
 Topics to be Discussed
• Consumer Preferences

• Budget Constraints

• Consumer Choice

• Marginal Utility and Consumer Choices

52
 Budget Constraints
• Preferences do not explain all of the consumer b
ehavior.

• Budget constraints also limit an individual’s abilit

y to consume in light of the prices they must pay
for various goods and services.

53
 Budget Constraints
• The Budget Line
– The budget line indicates all combinations of two
commodities for which total money spent equals total
income.
– Let F equal the amount of food purchased, and C is
the amount of clothing.
– Price of food = Pf and price of clothing = Pc
– Then Pf F is the amount of money spent on food, and
Pc C is the amount of money spent on clothing.
– The budget line then can be written:

P FF  P C C  I
54
 Budget Constraints
Market Basket Food (F) Clothing (C) Total Spending
Pf = ($1) Pc = ($2) PfF + PcC = I

A 040 $80
B 2030 $80
D 4020 $80
E 6010 $80
G 800 $80
55
 Budget Constraints
Clothing
Pc = $2 Pf = $1 I = $80
(units
per week)
A Budget Line F + 2C = $80
(I/PC) = 40

B 1
30 Slope  C/F  -  - PF/PC
2
10
D
20
20
E
10
G Food
0 20 40 60 80 = (I/PF) (units per week)
56
 Budget Constraints
• A budget line describes the combinations of goods that can be
purchased given the consumer’s income and the prices of the
goods.

• Line AG (which passes through points B, D, and E ) shows the

budget associated with an income of $80, a price of food of PF = $1
per unit, and a price of clothing of PC = $2 per unit.

• The slope of the budget line (measured between points B and D) is

• −PF /PC = −10/20 = −1/2.

57
 Budget Constraints
• Using equation (3.1), we can see how much of C must be given up to
consume more of F. We divide both sides of the equation by PC and then
solve for C:
• C = (I/PC) - (PF/PC)F (3.2)
• Equation (3.2) is the equation for a straight line; it has a vertical intercept of
I/PC and a slope of −(PF/PC).
• The slope of the budget line, −(PF/PC), is the negative of ratio of the prices
of the two goods.
• The magnitude of the slope tells us the rate at which the two goods can be
substituted for each other without changing the total amount of money
spent.
• The vertical intercept (I/PC) represents the maximum amount of C that can
be purchased with income I. Finally, the horizontal intercept (I/PF) tells us
how many units of F can be purchased if all income were spent on F.

58
 Budget Constraints
• The Effects of Changes in Income and Prices
– Income Changes
– An increase in income causes the budget line to shift
outward, parallel to the original line (holding prices
constant).
– A decrease in income causes the budget line to shift
inward, parallel to the original line (holding prices
constant).
– we can see that a change in income alters the vertical
intercept of the budget line but does not change the
slope (because the price of neither good changed)

59
 Budget Constraints
Clothing
(units A increase in
per week) income shifts
80 the budget line
outward

60
A decrease in
income shifts
40 the budget line
inward

20 L3
(I = L1 L2
$40) (I = $80) (I = $160)
Food
0 40 80 120 160 (units per week)
60
 Budget Constraints
• The Effects of Changes in Income and
Prices
– Price Changes
• If the price of one good increases, the budget line shifts
inward, pivoting from the other good’s intercept.
• If the price of one good decreases, the budget line shifts
outward, pivoting from the other good’s intercept.
• This rotation makes sense because a person who consumes
only clothing and no food is unaffected by the price change.
However, someone who consumes a large amount of food
will experience an increase in his purchasing power.
Because of the decline in the price of food, the maximum
amount of food that can be purchased has doubled.
61
 Budget Constraints
Clothing
(units An increase in the
per week) price of food to
$2.00 changes
the slope of the
budget line and
rotates it inward (L3).
A decrease in the
40 price of food to
$.50 changes
the slope of the
budget line and
L3 L1 L2 rotates it outward (L2).

(PF = 1) (PF = 1/2)

(PF = 2) Food
40 80 120 160 (units per week)
62
 Budget Constraints
• The Effects of Changes in Income and Prices
– Price Changes
If the price of two goods increases, but the ratio of
the two prices is unchanged, then the slope will not
change.
However, the budget line will shift inward to a point
parallel to the original budget line.

63
 Topics to be Discussed
• Consumer Preferences

• Budget Constraints

• Consumer Choice

• Marginal Utility and Consumer Choices

64
 Consumer Choice
• Given preferences and budget constraints, we can now
determine how individual consumers choose how much
of each good to buy.
• Consumers choose a combination of goods that will maxi
mize the satisfaction they can achieve, given the limited
budget available to them.
• The maximizing market basket must satisfy two condition
s:
– It must be located on the budget line.
– Must give the consumer the most preferred combination of good
s and services(highest utility).

65
 Consumer Choice
1) It must be located on the budget line.
•Any market basket to the left of and below the budget line leaves
some income unallocated income which, if spent, could increase the
consumer’s satisfaction.
•Of course, consumers can and often do save some of their incomes
for future consumption. At this point, however, we will keep things
simple by assuming that all income is spent now.
•Note also that any market basket to the right of and above the budget
line cannot be purchased with available income.
•Thus, the only rational and feasible choice is a basket on the budget
line.

66
Consumer Choice
•A consumer maximizes
satisfaction by choosing
market basket A. At this
point, the budget line and
indifference curve U2 are
tangent, and no higher level
of satisfaction (e.g., market
basket D) can be attained.
At A, the point of
maximization, the MRS
between the two goods
equals the price ratio. At B,
however, because the MRS
[−(−10/10) = 1] is greater
than the price ratio (1/2),
satisfaction is not
maximized.

67
 Consumer choice
• Remember that of the three curves, the outermost curve, U3, yields
the greatest amount of satisfaction, curve U2 the next greatest
amount, and curve U1 the least.
• Note that point B on indifference curve U1 is not the most preferred
choice because a reallocation of income in which more is spent on
food and less on clothing can increase the consumer’s satisfaction.
• In particular, by moving to point A, the consumer spends the same
amount of money and achieves the increased level of satisfaction
associated with indifference curve U2.
• In addition, note that baskets located to the right and above
indifference curve U2, like the basket associated with D on
indifference curve U3, achieve a higher level of satisfaction but
cannot be purchased with the available income. Therefore, A
maximizes the consumer’s satisfaction.
68
Consumer choice

69
 Consumer choice
• We see from this analysis that the basket which maximizes satisfaction
must lie on the highest indifference curve that touches the budget line.
• Point A is the point of tangency between the indifference curve U2 and
the budget line. At A, the slope of the budget line is exactly equal to the
slope of the indifference curve. Because the MRS (−􏰀C/􏰀F) is the
negative of the slope of the indifference curve, we can say that
satisfaction is maximized (given the budget constraint) at the point
where
• MRS = PF/PC (3.3)
• This is an important result: Satisfaction is maximized when the
marginal rate of substitution (of F for C) is equal to the ratio of the
prices (of F to C). Thus the consumer can obtain maximum satisfaction
by adjusting his consumption of goods F and C so that the MRS equals
the price ratio.

70
 Consumer Choice
Recall, the slope of an indifference curve is:
C
MRS  
F
Further, the slope of the budget line is:
PF
Slope  
PC
• Therefore, it can be said that satisfaction is maximized w
here:
PF
MRS 
PC
• It can be said that satisfaction is maximized when
marginal rate of substitution (of F and C) is equal to
the ratio of the prices (of F and C).
71
 Consumer Choice
Designing New Automobiles (II)

• Consider two groups of consumers, each wishin

g to spend $10,000 on the styling and performan
ce of cars.
• Each group has different preferences.
• By finding the point of tangency between a grou
p’s indifference curve and the budget constraint
auto companies can design a production and ma
rketing plan.

72
Designing New Automobiles (II)
Styling

$10,000 These consumers

are willing to trade
off a considerable
amount of styling
for some additional
performance

$3,000

$7,000 $10,000 Performance

73
Designing New Automobiles (II)
Styling

$10,000 These consumers

are willing to trade
off a considerable
$7,000 amount of
performance for
some additional
styling

$3,000 $10,000 Performance

74
 Topics to be Discussed
• Consumer Preferences

• Budget Constraints

• Consumer Choice

• Marginal Utility and Consumer Choices

75
 Marginal Utility and
Consumer Choice
We showed graphically how a consumer can maximize his
or her satisfaction, given a budget constraint. We do this
by finding the highest indifference curve that can be
reached, given that budget constraint.

Because the highest indifference curve also has the highest

attainable level of utility, it is natural to recast the
consumer’s problem as one of maximizing utility subject to
a budget constraint.

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 Marginal Utility and
Consumer Choice
Marginal Utility

• Marginal utility measures the additional satisfaction

obtained from consuming one additional unit of a good.
• Example
– The marginal utility derived from increasing from 0 to 1 units of
food might be 9
– Increasing from 1 to 2 might be 7
– Increasing from 2 to 3 might be 5
• Observation: Marginal utility is diminishing (watching TV;
eating hamburgers)

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 Marginal Utility and
Consumer Choice
Diminishing Marginal Utility

• The principle of diminishing marginal utility

states that as more and more of a good is
consumed, consuming additional amounts
will yield smaller and smaller additions to u
tility.

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 Marginal Utility and
Consumer Choice

• Marginal Utility and the Indifference Curve

Because all points on an indifference curve generate the same level
of utility, the total gain in utility associated with the increase in F
must balance the loss due to the lower consumption of C.

• Formally:

• Rearranging: 0  MUF(F)  MUC(C)

 C / F   MU F / MU C

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 Marginal Utility and
Consumer Choice
• Because:
 C / F   MRS of F for C
MRS  MUF/MUC
• When consumers maximize satisfaction then:
MRS  PF/PC
• Since the MRS is also equal to the ratio of the marginal ut
ilities of consuming F and C, it follows that:
MUF/MUC  PF/PC
• Which gives the equation for utility maximization:
MU F / PF  MU C / PC

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 Marginal Utility and
Consumer Choice

• Total utility is maximized when the budget

is allocated so that the marginal utility per
dollar of expenditure is the same for each
good.

• This is referred to as the Equal Marginal P

rinciple.

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 Marginal Utility and
Consumer Choice
To see why this principle must hold,
•Suppose that a person gets more utility from spending an additional
dollar on food than on clothing.

•In this case, her utility will be increased by spending more on food.

•As long as she finds that a dollar spent on food gives her more utility
than a dollar spent on clothing, she has to continue to spend money on
food till the satisfaction derived from the last dollar spent in the two
cases is equal.

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 Summary
• People behave rationally in an attempt to maximize satisf
action from a particular combination of goods and servic
es.
• Consumer choice has two related parts: the consumer’s
preferences and the budget line.
• Consumers make choices by comparing market baskets
or bundles of commodities.
• Indifference curves are downward sloping and cannot int
ersect one another.
• Consumer preferences can be completely described by
an indifference map.
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 Summary
• The marginal rate of substitution of F for C is the maxim
um amount of C that a person is willing to give up to obta
in one additional unit of F.
• Budget lines represent all combinations of goods for whic
h consumers expend all their income.
• Consumers maximize satisfaction subject to budget cons
traints.

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 Questions
• Suppose that Bridget and Erin spend their incomes on two goods,
food (F) and clothing (C). Bridget’s preferences are represented by
the utility function U(F, C) = 10FC, while Erin’s preferences are
represented by the utility function U(F,C) = 0.20F2C2.
• a. With food on the horizontal axis and clothing on the vertical axis,
identify on a graph the set of points that give Bridget the same level
of utility as the bundle (10, 5). Do the same for Erin on a separate
graph. 
• b. On the same two graphs, identify the set of bundles that give
Bridget and Erin the same level of utility as the bundle (15, 8). 
• c. Do you think Bridget and Erin have the same preferences or
different preferences? Explain.

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 Answers
• Bridget’s utility will be: 
• U(F, C) = 10FC = 10 x 10 x 5 = 500
• Similarly, Erin’s utility will be: 
• U(F,C) = 0.20F2C2 = 0.20 x 102 x 52 = 500
• Bridget and Erin have the same level of satisfaction for the given utility functions when
their consumption bundle is (10,5)
• Bridget’s utility will be: 
• U(F, C) = 10FC = 10 x 15 x 8 = 1200
• Similarly, Erin’s utility will be: 
• U(F,C) = 0.20F2C2= 0.20 x 152 x 82 = 2880
• Bridget and Erin have a different level of satisfaction for the given utility functions
when their consumption bundle is (15,8).
• So, for the consumption bundle (10,5), despite different utility functions, Bridget and
Erin have equal satisfaction levels or the utility, 500. One can conclude that Bridget
and Erin have the same preferences for the bundle.
• When the consumption bundle is (15,8), their utilities are different. Bridget’s utility is
less than Erin’s. So, Bridget will prefer a different combination bundle of food and
clothing.

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 Question
• Julio receives utility from consuming food (F) and clothing (C) as
given by the utility function U(F,C) = FC. In addition, the price of
food is $2 per unit, the price of clothing is $10 per unit, and Julio's
weekly income is $50.
• a. What is Julio's marginal rate of substitution of food for clothing
when utility is maximized? Explain. 
• b. Suppose instead that Julio is consuming a bundle with more food
and less clothing than his utility-maximizing bundle. Would his
marginal rate of substitution of food for clothing be greater than or
less than your answer in part a? Explain

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 Answers
• a. Julio's marginal rate of substitution of food for clothing
when his utility is maximized is 0.2.
• MRS=Pf/Pc
• b. Julio's marginal rate of food substitution for clothing
does not change as the prices are the same, although he
consumes a bundle with more food and less cloth.

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