Manual for economics with work exercises. By elsa t. silon/ramon a. bernardo/melani c.

quilloy

THEORY OF CONSUMER BEHAVIOR

Total and Marginal Utility

- The law behind the downward sloping demand curve is explained by the theory of consumer
behavior.
- Basic terminologies in understanding the concept include the following:
o Utility.
 It means the satisfaction obtained from the goods and services that a consumer
consumes.
o Total Utility [TU]
 It refers to the total amount of satisfaction one obtains from the consumption of
goods and services.
o Marginal Utility [MU]
 It is the additional satisfaction obtained from the consumption of an additional
unit of good and services.
 Mathematically, MU is the slope of the TU. The formula is as follows:

MU = ∆TU
∆Q

The Law of Diminishing Marginal Utility [MU]

- States that the successive consumption of the same good or service increases the total utility
[TU], but at some point the total utility will reach a maximum and beyond this point, the total
utility diminishes.
- To better explain the theory, here is an example.
o After a long walk under the heat of the sun, you will feel very thirsty.
o The first glass of water you will take will definitely give you satisfaction, while the second
glass will add more satisfaction.
o As you take more glasses of water, the satisfaction level reaches a maximum.
o And if you continue on drinking the water, most probably you will experience
dissatisfaction because you will have unpleasant feeling.
- To provide a numerical example, refer to Table below.

Quantity Total Utility [TU] Marginal Utility [MU]

1 10 -

2 18 8

3 24 6

4 28 4

5 30 2

6 30 0

7 28 -2
 o The first column may be referred to the glasses of water.
 The first glass of water gives 10 units of satisfaction.
o The second glass, on the other hand provides an additional satisfaction of 8 units
thereby making your total satisfaction equal to 18 units.
o The third glass of water adds 6 units of satisfaction, hence the total satisfaction is
already 24 units.
o When you had your 6th glass of water, notice that there is no additional derived [zero],
while the 7th glass f water resulted to a negative 2 units of satisfaction which resulted to
a decrease in total satisfaction from 30 units to 28 units.
 This is saying that the satisfaction level reaches the maximum from the intake of
the 5th glass of water and taking more will not add or may yield dissatisfaction.

- The graphical illustration of the law of diminishing utility is presented in Figure below.

- The total utility [TU] curve shows an increasing trend until the 5 th item [Quantity], the maximum
point of the TU.
- After which the TU curve slopes downward.
o On the other hand, the values of the marginal utility [MU] are diminishing [from 8 to 6
then 4 and so forth-.
- The positive values of the MU signifies that there is added satisfaction [although diminishing]
derived from the additional consumption of the goods.
- The zero value suggests that there is no added satisfaction because the maximum is already
reached.
- The negative MU means that the additional consumption will result to negative satisfaction
[dissatisfaction] because it causes the total utility to decrease.
o Assumptions about the consumer’s behavior:
1. Consumers are able to rank their preferences for the goods and services.
2. Consumers are consistent or transitive
3. Consumers prefer ‘more’ of the goods than ‘less’ of it.
Indifference Curve

- Indifference curve is a curve which shows different combinations of two goods which yield the
same level of satisfaction.
- The following are the characteristics of indifference curves:
1. They slope downward and towards the right.
2. They do not intersect.
3. They are convex in shape.

Indifference schedule

Points Quantity A Quantity B

A 11 3

B 8 4

C 5 6

D 3 10

E 2 15

Example: Provided below are indifference schedules from utilities 100, 200 and 300. These data are
plotted in the graph below.

Utility = 100 Utility = 200 Utility = 300

A B A B A B

11 12 20 20 35 35

15 7 22 15 37 20

20 5 25 10 40 17

28 3 35 8 45 14

38 2 50 7 53 13
The Budget Line and the Optimum Combination
- A budget line shows the infinite points of combinations in the consumption of two commodities
that the same budget can buy at constant prices.

Budget schedule

A B

50 0

45 2

40 4

35 6

30 8

25 10

20 12

15 14

10 16

5 18

0 20
[Assume that the budget is P500; PA = 10; PB = 25]

- The quantities of commodities at any point along a budget line indicate the purchasing capacity.
o Together with the indifference curves, the optimum combination of commodities that a
given budget can purchase is obtained at the tangency of the budget line and
indifference curves.

Substitution Effect
- Assume two close commodities with almost the same price, say detergent soap A and detergent
soap B.
o When the price of detergent soap A increases from P20 to P25 per bar [while the price
of detergent soap B remains constant at P20 per bar],
 the consumer tends to substitute detergent soap B for detergent soap A.
- The substitution manifests that a higher utility is obtained by substituting detergent soap B for
detergent soap A because the latter has increased its price.
- In effect, less detergent soap A will be bought because its price has increased [say from 100 T
unites to 80 T units].
- As the law of demand states, the higher the price of the commodity, the lesser quantity will be
demanded and vice versa.
- This is exactly what happened to detergent soap A.
- See illustration below for further clarification.
 Price of Quantity
detergent soap A Demanded for
detergent soap A

20 100 T

25 80 T