CONSUMER DEMAND

THEORY
TOTAL AND MARGINAL UTILITY
• WHY DOES AN INDIVIDUAL DEMAND FOR A PARTICULAR
COMMODITY?
• IT IS BECAUSE OF THE SATISFACTION OR UTILITY RECEIVED FROM
CONSUMING IT.
• UP TO A POINT, THE MORE UNITS OF A COMMODITY THE INDIVIDUAL
CONSUMES PER UNIT OF TIME, THE GREATER THE TOTAL UTILITY
RECEIVED.
• ALTHOUGH TOTAL UTILITY INCREASES, THE EXTRA OR MARGINAL
UTILITY RECEIVED FROM CONSUMING EACH ADDITIONAL UNIT OF
THE COMMODITY USUALLY DECREASES.
QX TUX MUX
0 0 ---
1 10 10
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2
 TUx

Saturation Point

30

TU Curve

0 Qx
6
TUx/MUx Saturation Point

30

TU Curve

10

0 Qx
1 6
-2
MU Curve
From the TUx Schedule below, derive the MUx
schedule (present this in tabular form), and plot
the TUx and MUx schedules and indicate the
saturation point.

Qx 0 1 2 3 4 5 6 7 8 9

TUx 0 7 13 18 22 25 27 28 28 27
CONSUMER EQUILIBRIUM
• OBJECTIVE OF A CONSUMER:
• MAXIMIZE TOTAL UTILITY OR SATISFACTION DERIVED FROM
SPENDING PERSONAL INCOME.
• IT HAPPENS WHEN THE CONSUMER IS ABLE TO SPEND PERSONAL
INCOME IN SUCH A WAY THAT THE UTILITY OR SATISFACTION OF THE
LAST PESO SPENT ON VARIOUS COMMODITIES IS THE SAME.
• MATHEMATICALLY, THIS IS EXPRESSED AS:
• MUx = MUy = ….
Px Py
* Constraint: PxQx + PyQy + … = M (the individual’s income)
Example
Q 1 2 3 4 5 6 7 8
MUx 16 14 12 10 8 6 4 2
MUy 11 10 9 8 7 6 5 4
Suppose Px = P2 while Py = P1 and the individual’s income is P12 per time period
and is all spent. How should this income be spent on the two commodities such
that the consumer attains equilibrium?

Specifically,
1) How many pesos must be spent on X?
2) How many pesos must be spent on Y?
3) What is the individual’s overall TU for both commodities at equilibrium?
SOLUTION:
(1) MUx = Muy 12 = 6 6=6
Px Py P2 P1

(2) PxQx + PyQy = M (P2)(3) + (P1)(6) = P12 12 = 12

Some points to ponder:
• WITH WHAT IS CONSUMER DEMAND THEORY CONCERNED?
• IT IS CONCERNED WITH THE INDIVIDUAL’S DEMAND CURVE FOR A
COMMODITY – HOW IT IS DERIVED AND THE REASON FOR ITS
LOCATION AND SHAPE.
• WHY DO WE STUDY CONSUMER DEMAND THEORY?
• IT IS TO LEARN MORE ABOUT THE MARKET DEMAND FOR A
COMMODITY (WHICH IN BASIC ECONOMICS IS THE HORIZONTAL
SUMMATION OF ALL INDIVIDUALS’ DEMAND CURVES FOR A
COMMODITY, THAT IS, MDx = ƩQDx)
A Utility Function refers to a particular individual
and such reflects the tastes of this individual.
• Do different individuals have differing tastes?
• What happens to the utility function of an individual if his taste
changes?
• Consider the following, derive MUx schedule and plot TUx and MUx.

Qx 0 1 2 3 4 5 6 7
TUx 0 4 14 20 24 26 26 24
MUx
Some points to ponder:
• What constraints or limitations does the consumer face in seeking to
maximize the total utility from personal expenditures?
• The consumer faces income and price constraint or limitation. With
his given income and fixed prices of commodities, the rational
consumer seeks to maximize total utility from expenditures.
• What two conditions must be satisfied to achieve equilibrium?
(1) The MU of the last peso spent on X must be equal to the MU of the
last peso spent on Y and so on for other commodities
(2) The amount of money spent on X plus the amount of money spent
on Y plus the amount of money spent on all other commodities
must equal the consumer’s money income.
Qx 1 2 3 4 5 6 7 8 TOTAL
MUx 11 10 9 8 7 6 5 4 60
MUy 19 17 15 13 12 10 8 6 100

Assuming the prices of X and Y are the same at P1, and the
individual’s money income is P8, per time period and is all spent,
(1) indicate how each of the peso will be spent on X and Y (where
will the 1st peso, 2nd, 3rd….and 8 peso goes);
(2) what is the overall total utility received by the consumer?

Answer: 2x and 6y
1st, 2nd, 3rd, 4th, 5th peso on Good y;
6th, 7th peso on Good x;
8th peso on Good y . Therefore TU = 107 utils
Suppose prices of X and Y are P2 and income is P20.

Qx MUx MUy
1 16 15
2 14 13
3 11 12
4 10 8
5 9 6
6 8 5
7 7 4
8 6 3
9 5 2
10 3 1
11 1 0
(a) How will the individual spend his income
in order to achieve equilibrium?
• MUx = MUy 8 = 8 4=4
Px Py P2 P2

PxQx + PyQy = (P2)(6) + (P2)(4) = P20

P12 + P8 = P20
P20=P20

Therefore: The individual should buy 6 units of X and 4 units of Y.

(b) If commodity y is savings, how would the
equilibrium condition be affected?
• If Y referred to savings rather than to a consumption
good and the MUy schedule represented the utility
received by the individual from saving part of his
income, the equilibrium condition for this consumer
would remain completely unchanged.
• Hence, in order to maximize the total utility from his
income, the consumer must spend P12 of his income
to purchase 6 units of X and save the remaining P8.
(c) Suppose that the MU of the 4th unit of Y was 7
instead of 8, what effect would this have on the
equilibrium condition?
• In order to be in equilibrium this individual
should buy a little more than 6 units of X and a
little less than 4 units of Y.
• If the consumer could not purchase fractions of
a unit of X and Y, then the individual could
continue to buy 6 units of X and 4 units of Y but
now the equilibrium condition would hold only
approximately and not precisely.
(d) Suppose that the MUx increased continuously as the individual
consumed more of X and the MUy schedule remain unchanged. How
should the consumer rearrange his expenditures to maximize his total
utility?
• If the MUx had been rising continuously rather
than falling, this individual should spend all of
his income to buy 10 units of X in order to
maximize total utility.
Q 1 2 3 4 5 6 7 8
MUx 16 14 12 10 8 6 4 2
MUy 11 10 9 8 7 6 5 4
(e) Over what range of the MU function do
consumers operate?
• Since in the real world we observe that consumers
spend their income on many commodities than on a
single one, consumers operate over the falling portion
of MU function.
• In addition, the MU function also becomes irrelevant
past the saturation point because the consumer
would not be willing to get more of this commodity
even if it were free. Thus, the relevant portion of the
MU function is its positive but falling portion.
Case: why is water, which is essential to life, so
cheap while diamonds, which are not essential to
life, so expensive?
• Does TU received from water exceed the TU received from
diamonds?
• YES
• Does the price we are willing to pay for each unit of a
commodity depends on the TU or MU?
• MU
• Since we consume so much water, the MU of the last unit of
water consumed is very low. Hence, we are only willing to
pay a very low price for this last unit of water consumed.
• On the other hand, since we purchase so few
diamonds, the MU of the last diamond purchased is
very high.
• Therefore, we are willing to pay a high price for this
last diamond and for all other diamonds purchased.
• Note: Classical economists did not distinguish TU from
MU and thus they were unable to resolve this so
called “water-diamond paradox”.
INDIFFERENCE CURVES
• ICs can show consumer’s tastes and equilibrium
in graphic form.
• An IC shows the various combinations of
commodity x and commodity y which yield equal
utility or satisfaction to the consumer
• ICs show an ordinal rather than cardinal measure
of utility because higher ICs indicate higher
levels of satisfaction while lower ICs less
satisfaction.
 I II III IV
X Y X Y X Y X Y
2 13 3 12 5 12 7 12
3 6 4 8 5.5 9 8 9
4 4.5 5 6.3 6 8.3 9 7
5 3.5 6 5 7 7 10 6.3
6 3 7 4.4 8 6 11 5.7
7 2.7 8 4 9 5.4 12 5.3