Consumer Behavior and Utility Maximization

Income Effect
It is the impact that a change in the price of a product has on a
consumer’s real income and consequently in the quantity demanded of that
good.

If the price of a normal good increases the real income or purchasing

power declines. And if the price of a good declines, it increases the consumer’s
real income, enabling buyers to purchase more of them.

Substitution Effect
It is the impact that a change in a product’s price has on its relative
expensiveness and consequently on the quantity demanded.

When the price of a product falls, that product becomes cheaper relative
to all other products. Consumes will substitute the cheaper products for the
other products that are now relatively expensive.

Law of Diminishing Marginal Utility

The principle that as a consumer increases the consumption of a good or
service, the marginal utility obtained from each additional unit of the good or
services decreases.

Total Utility- is the total amount of satisfaction or pleasure a person

derives from consuming some specific quantity

Marginal Utility- is the extra satisfaction a consumer realizes from an

additional unit of that product.

Tacos Total Marginal As more of a product is consumed,

Consumed Utility Utility
total utility increases at diminishing
per meal TU2- TU1
rate, until it reaches a maximum
0 0
point and then it declines
1 10
2 18 Marginal utility reflects the changes
3 24 in total utility. Thus MU diminishes
4 28 with increased consumption, until it
becomes zero when TU is at
5 30
maximum, and is negative when TU
6 30 declines
7 28

a. Plot the Total Utility curve

b. Compute for the Marginal Utility? MU= TU 1- TU0
c. Graph the MU curve
 The Cost of Production

Economic cost
Are the payments a firm must make, or the incomes it must provide, to
attract the resources it needs away from the alternative production
opportunities

Explicit cost (Revealed or exposed) are the monetary payments or cash

expenditures it makes to those who supply labor services, materials, fuel,
transportation services and the like

Implicit cost (present but not obvious) are the opportunity cost of using
its self owned, self employed resources.

Normal Profits
Is defined as the minimum sum which the capitalist must receive in
order to make him invest his capital in a particular business

The payment made by a firm to obtain and retain entrepreneurial ability:

the minimum income entrepreneurial ability must receive to induce it to
perform entrepreneurial functions for firm

The economist includes as cost of production all the cost explicit and
implicit, including normal profit, required to attract and retain resources in a
specific line of production.

Economic Profit (Pure Profit)

It is the Total revenue less economic cost (implicit and explicit)
If the firm’s total revenue exceeds all its economic cost any residual goes
to the entrepreneur. That residual is called economic or pure profit.

Economic Profit= TR- EC

Short Run- Fixed Plant

This is a period to brief for a firm to alter its plant capacity, yet long
enough to permit a change in the degree to which the fixed plant is used

Long Run- Variable Plant

This is a period long enough for it to adjust the quantities of all the
resources that it employs including the plant capacity. The firms can enter or
leave the industry.

Short- Run Production Relationship

A firm’s cost of producing a specific output depends on the price of the
needed resources and the quantities of resources (inputs) needed to produce
that output.

Total Product (TP) is the total quantity, or total output, of a particular

good produced.
 Marginal product (MP) is the extra output or added product associated
with adding a unit of a variable resource, (labor resource)

MP= Change in TP
Change in labor input

Average product (AP), also called labor productivity, it is the output per
unit of labor input

AP= TP
Units of Labor

Law of Diminishing Returns

It states that as successive units of variable resources are added to a fix

resource beyond some point the extra or marginal product that can be
attributed to each additional unit of the variable resource will decline.

Units of Labor Total Product Marginal product Average Product

∆ in TP/ ∆ Labor TP/ Labor input
input
0 0
1 10
2 25
3 45
4 60
5 70
6 75
7 75
8 70

a. Plot TP curve
b. Compute for MP and AP and plot the corresponding curves
c. From the illustration explain the three stages of production

As a variable resource is added to fixed amounts of other resources, the total

product that results will eventually increase by diminishing amounts, each a
maximum and then it declines
Short Run Production Cost

A. Fixed, Variable and total cost

Fixed Cost (TFC)

These are costs that in total do not vary with changes in output. It’s a
portion of the total cost which remains independent of the level of output.
These are associated with the very existence of a firm’s plant and
therefore must be paid even if its output is zero. (Rent payment, interest
payment on loans, building and equipment, insurance premiums)

Variable Cost (TVC)

These are cost that change with the level of output. (Wages, raw material
expenditure, fuel, power, transportation)

Total Cost (TC)

TC= TFC+ TVC

Cost schedule of Sturgen textile Mills

TP Total Fixed Cost Total Variable Total Cost
Yards of Cloth TFC Cost TC
TVC TC = TFC+ TVC
0 100 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930

a. Compute for TC and plot the curve.

b. Plot TVC and TFC curve

B. Per Unit, or Average Cost

Average Fixed Cost (AFC) for any output level is found by dividing total
fixed cost (TFC) by that output (Q)

AFC= TFC
Q
As you increase your output you reduces your average fixed cost
this process is called “spreading the overhead”
 Average Variable Cost (AVC) for any output level is calculated by
dividing total variable cost (TVC) by that output (Q)

AVC= TVC
Q
At very low levels of output reduction is relatively inefficient and
costly, because the firms fixed plant is understaffed, average variable
cost is relatively high
As output expands, however greater specialization and better use
of the firms’ capital equipment yield more efficiency and variable cost per
unit f output declines.

As still more variable resources are added a point is reached

where diminishing returns are incurred.

The firm’s capital equipment is now staffed more intensively and

therefore each added input does increase output. AVC eventually
increases.

Average Total Cost (ATC) for any output level is found by dividing total
cost by that output, or by adding AFC and AVC at that output

ATC= TC
Q

ATC= AFC+ AVC

TP or Q TFC TVC TC Average Average Average

fixed cost Variable Cost
AFC Cost AVC
TFC/ TP TVC/TP AFC+AVC

0 100 0 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030

a. Compute for AFC, AVC and AC

b. Plot the curve respectively
c. Explain why AC curve is U shape?
 C. Marginal Cost (MC)
It is the extra or additional cost of producing 1 more unit out output

MC= Change in TC
Change in Q
TP (Q) TFC TVC TC Marginal cost
MC
∆ in TC/ ∆ Q
0 100 0 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 640
8 100 650 750
9 100 780 880
10 100 930 1030

a. Compute for MC and plot the MC Curve

MC is cost the firm can control directly and immediately. Specifically,

MC designates all the cost incurred in producing the last unit of
output. Thus it also designates the cost that can be saved by not
producing the last unit.

MC at first declines a sharply, reaches a minimum, and then rises

rather abruptly. This reflects the fact that variable cost and total cost
increase first by decreasing amount and then by increasing amount.

D. Relationship of the marginal cost curve to average, total and

average variable cost curves.

The marginal cost MC curve cuts through the average total cost
(ATC) curve and the average variable cost (AVC) curve at their
minimum points.

When MC is below average total cost, ATC falls: When MC is above

average total cost, ATC rises. Similarly when MC is below average
variable cost, AVC falls: when MC is above average variable cost,
AVC rises
 Revenue and Changes in Output

Total revenue (TR) -refers to the proceeds from total sales of the firm
-total revenue curve is derived from the demand curve
facing the firm

Average Revenue (AR) - it is the revenue received for each unit sold
- AR is equal to price

Marginal Revenue (MR) - it is the change in revenue attributable to a unit

change in output or sales

Price Quantity Total Revenue Average Marginal

Demanded P x Qd Revenue Revenue
TR /Qd ∆ in TR/∆ Qd
2.50 0
2.25 2500
2.00 5000
1.75 7500
1.50 10000
1.25 12500
1.00 15000
0.75 17500
0.50 20000
0.25 22500
0 25000

a. Compute for TR, AR and MR

b. Illustrate TR, AR and MR curve.

c. Explain why TR curve is shaped that way?

d. Explain the relationship of AR and MR curve?

 Profit Maximization

The amount of profit or losses which can be earned or incurred by

the firm would depend on the relationship between revenue and cost.

Profit is the amount by which total revenue exceeds total cost

Profits= TR-TC
TR> TC profit
TR< TC losses
TR=TC normal profit/breakeven point

A. Total Cost-Total revenue approach

Marikina Abaca Slipper Store

TP Total Cost (PhP) Total Revenue Total Profit
(PhP) TR-TC
0 3.00 0
1 4.40 9
2 6.40 16
3 7.80 21
4 8.80 24
5 10.00 25
6 12.60 24
7 16.80 21
8 22.40 16
9 28.80 9
10 36.00 0

a. Compute for the total profit or loss

b. Illustrate the TC and TR curve
c. Determine the regions of economic profit, loss situation and break
even point?
d. At what level of production the firm would realized maximum profit

B. Marginal Cost – Marginal Revenue approach

a. Using the same schedule, create a separate table compute for MC

and MR
b. Illustrate the MC and MR and determine the profit maximization
point